Potential Consequences Had The U.S. Defaulted

By Marc Davis | July 28, 2011 AAA

With little time to spare, the U.S. government dodged a disastrous default on its debts, as the House and Senate passed an emergency bill to raise the country's debt ceiling and President Obama quickly signed it into law. The new legislation authorizes an increase of $2.4 trillion in additional government borrowing.

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But what exactly would've happened or could've happened if a bi-partisan deal on raising the country's debt ceiling was not consummated? A default means that some or all of the people, businesses, institutions and governments that the U.S. owes money to would not be paid. They may be paid eventually, but not in the immediate wake of today's deadline when the U.S. would've theoretically run out of money. (For additional reading, refer to How Countries Deal With Debt.)

The Worst-Case Scenario
A worst-case scenario is depicted below, but none of this or only some of it might've occurred if the U.S. had defaulted. Depending on how quickly and comprehensively the post-default problems were resolved, the U.S. economy may not have suffered a long-term crippling injury. In the most extreme case, it could take years or a decade or more for the economy to recover sufficiently after a government default for the U.S. to regain its formerly stable economic footing.

Money would continue to come in to the government, but not at the necessary rate to pay all its obligations because the debt ceiling of $14.3 trillion - the amount of money the U.S. may borrow, as mandated by law - would have been reached if the ceiling had not been raised.

Consequently, the government would have had to decide who gets paid and who doesn't. Entitlement programs might have been among the first to feel the cash crunch. Social Security, Medicare and Medicaid recipients might have been short changed. Military veterans who receive pensions and other retired government workers, including legislators, judges, federal attorneys and others might have seen a reduction in their monthly checks. Defense contractors - the big firms that manufacture weaponry, aircraft, seagoing vessels - may also have been hit with partial payments of what the government owed them, or payment might have been suspended entirely until more money became available.

Another immediate consequence of a default is a lowering of America's credit rating by the major ratings agencies, Moody's and Standard & Poor's. That means with U.S. Treasuries deemed more risky, higher interest rates would have to be offered to attract lenders. The result of higher rates would ripple through the entire U.S. and global economies.

Impact on the Individual Consumer
For the individual consumer, there'd be higher rates for credit card purchases, mortgages, consumer loans of every variety. For businesses, both mature and start-up, higher rates would be charged for loans to expand, replenish inventory, purchase new technologies, hire more personnel. Stock prices would decline accordingly as economic growth is hampered. Venture capital, used to finance new businesses, would also become scarce as the economy slows, adding another obstacle to growth and employment.

Government funding of many programs which once stimulated economic growth would be curtailed or stopped. These would include government subsidies to industries such as agriculture, energy, transportation. Government grants and loans to college- and university-bound students would dry up, preventing gifted or financially strapped young people from getting a higher education and thus limiting their job opportunities.

As stock and real estate prices declined, endowment portfolios of colleges and universities would shrink, further limiting the funding of scholarship programs and student loans.

Primary research in technology, the sciences and medicine could also be impacted as both government and private sector money dried up. There may be a reduction in the development and testing of new drugs. Patents for high tech inventions and copyrights for computer software applications, may not come as frequently as they did when these sectors were powerful drivers of a booming economy.

Much needed infrastructure repair and rebuilding will of necessity be put on hold until more money became available to finance these projects.

A final result if this worst-case scenario had come to pass in all its horrifying economic damage, the U.S. standard of living would have declined unpleasantly, and the country's preeminent position in the world of economic stability and reliability, as a prime source of innovation in the sciences and technology, and as the most powerful nation militarily as a bulwark against war and aggression would be severely weakened.

But, that's only if the worst occurs.

The Bottom Line
Almost all economists and a majority of both Democrats and Republicans and most political independents agree that the debt crisis had to be resolved and U.S. debt obligations had be paid. The points of disagreement were in the methods and numbers - should taxes go up or remain where they are, should tax loop holes and deductions be eliminated, where should government expenses be cut?

These are the questions that the nation must confront again, if and when the higher debt ceiling is reached, which seems inevitable according to a consensus of economists if spending continues at its current pace and new government revenues are not obtained. If these problems are not solved, you can anticipate some or maybe all of the above calamities to befall the country with varying degrees of severity should the U.S. default on the new $2.4 trillion addition to the debt ceiling. See Credit Default Swaps: An Introduction.)

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