Officials will forecast future bond interest and principal cash flows and pay bondholders before paying (some of) the country’s other bills. Where necessary, they will retain a cushion to ensure future bond payments are guaranteed. In other words, a debt ceiling default does not mean a default on Treasury bonds.
No Treasury secretary is ever going to insist on this debt priority, because it reduces pressure on Congress to raise the debt ceiling. Moreover, the priority sets a very bad precedent, and not just because of the optics of paying bondholders (including foreign countries) over US citizens and businesses.
The method has never been tested and would be operationally complex. In a typical month, the Treasury makes thousands and thousands of payments, big and small. And government officials almost certainly must hold more cash than is strictly necessary, so that no chance is taken on bond payments. This means a sharp, sudden and brutal cut to all other government spending.
Consider August, when the drop-dead date is most likely to hit. 2019 is a good baseline, since cash flows between 2020 and 2022 were affected first by the pandemic and then by fiscal stimulus. If August 2023 follows the path of August 2019, Treasuries will have roughly $200bn of cash inflows and $400bn of cash outflows. But the bond payments will require a small amount of expenditure. The Treasury will pay them over the course of months, withholding some during the process and spending the remaining $200 billion. That means at least $200 billion in government spending will be cut suddenly unless the debt ceiling is raised.
Economically, this can be a huge blow. But even here, there is a nuance. Remember, this is spending that the US government has already committed to. This means that the moment the loan limit is raised, the money has to be spent — no ifs and buts. This certainty will reduce the initial economic shock.
Say there is a small business that is about to receive a payment from the government. If the money doesn’t arrive on the right date, the business owner is unlikely to panic. He or she will believe that it is only a matter of time before the government makes good on its bills.
Well, yes, well and maybe.
Besides, what is another name for unpaid bill increase?
So, it can be argued that the moment the debt ceiling is reached the US government will have to stop all spending for everything. It must not enter into any new debt agreements – whether acquired or whatever.
And wouldn’t it be fun if the argument could be used successfully?