Correcting the effects of default could take a great deal of time and some difficult decisions.
“Assume a week or two goes by with the government in default and finally the issue is resolved,” Reich says. “The mere fact that it has not paid its bills for two weeks would dramatically affect the trust creditors place in the US capacity to repay its debts. That trust would be seriously damaged for the future. Interest rates would be somewhat higher for a very long time. We are talking many years.”
Not everyone agrees, even among economists. It would not be as bad as, say, the 2008 collapse of Lehman Brothers, Capital Economics, a London-based research firm, wrote in recent analysis. "The crucial difference is that the US government would still be a going concern, with all the tax and spending powers of a sovereign state. Once the politicians reach a deal, there is no doubt that the US could return to servicing its debts as usual."
The answers vary – and are speculative – because investors worldwide would be operating in mostly uncharted territory.
The only time the US government has officially defaulted (some economists argue the US partially defaulted during the Great Recession when it moved off the gold standard) was in 1979. Congressional deadlock and an administrative error caused the government to pay bills seven days late. As Mark Zandi, chief economist at Moody’s Analytics warned the Senate Budget Committee last month, that accidental default cost the nation tens of billions of dollars. And it was viewed as a fluke.
“The last government default caused a 60 basis point jump in the federal interest rate that didn’t just disappear even though the government paid the bills a few days later. It remained there for a month of so,” says Roberton Williams a senior fellow at the Tax Policy Center.
Higher interest rates on US debt would drive up the federal deficit, perhaps dramatically, leaving the government with two options that would be even starker than they are today: rein in spending or raise taxes.
Given the political brinkmanship that has fueled the current crisis, Republicans would probably resist any tax hikes while Democrats would surely dig in their heels on spending, Mr. Williams says. “We all know how difficult both of those conversations would be.”
