Does the debt limit make default inevitable?

United States Dollar Bill

On October 1st Secretary Lew wrote in a letter to Speaker Boehner, reminding that the Treasury Department would no longer be able to fund the Federal Government, come October 17. The statutory debt limit, commonly referred to as the debt ceiling, has been reached in May of this year, forcing the Treasury to exert extraordinary measures, in order to keep the government funded and to avoid default. Lew warned that these measures will be exhausted on this date, meaning the U.S. Federal Government will no longer be able to pay off its obligations. Hence Lew urged Congress to pass a bill raising the debt limit.

Some Republicans have argued, that the U.S. would not default on its debt, while the rest of the country is expecting that this is what will happen. So who is right?

“I would dispel the rumor that is going around that you hear on every newscast that if we don’t raise the debt ceiling we will default on our debt. We won’t.”
- Sen. Tom Coburn (R-OK)

This remark is partly right, because the federal government has already hit the debt limit in May. His argument rests on the assumption that the incoming tax revenue will be enough to pay off all obligations without risking default, but it does not factor in, that the Treasury Department has to fund the whole government, including everything from social security to federal employee’s paychecks, in addition to payments on debt, without prioritizing one over the other.

Banking institutions, such as JP Morgan Chase, already sold all short-term exposure to U.S. debt. This includes all Treasuries that will be due between October 16 and November 6, or have payments scheduled during that timeframe. While they were not expecting a default, they still decided to liquidate this risk. This paints a clear picture of what might happen, should the treasury run out of money. The United States would neither be able to pay for upcoming payments, nor for maturing debt, until Congress increases the debt limit. It is debatable, whether this would mean a default on the whole debt, but running out of money would definitely result in higher interest on future debt and diminished confidence in U.S. Treasuries.
Therefore, it is not as easy as some Republicans on the hill make this debacle out to be, but a complete default also might not happen.

Image courtesy of 401(K) 2012 (CC BY-SA 2.0).