Could the US default over just $6bn?

US dollar notes being printed

It doesn't seem like a lot of money for the government of the largest economy in the world. But, if the current talks don't come to a resolution and the US doesn't come up with that amount on 31 October, then it can't pay the $6bn (£3.8bn) of interest that is due on government debt.

In other words, the answer is 'yes' and the US would default on a debt payment. And the ramifications would be simply dire.

This is if the US Congress doesn't raise the so-called debt ceiling, which I have written about before.

The debt ceiling is a limit on how much the US can borrow. The problem is, now it is preventing the US from borrowing to pay interest on money that it has already borrowed.

US Treasury Secretary Jack Lew has said that the money runs out on 17 October. With the government shutdown, it may have bought a little time.

When it comes down to it, the US could not pay salaries and other bills. But, if it doesn't pay its creditors, then it would technically default.

Deja vu?

Almost the same scenario happened before, in 1979.

During the Carter administration, Congress also wrangled with the President over the debt ceiling. The result was that they came to an agreement at the last minute.

But, the government couldn't write the cheques fast enough (remember those), so there was a delay in paying around $122m in interest to bondholders.

The bondholders eventually were paid with back interest. But, the estimated impact was to raise the cost of US borrowing by 0.6% or 60 basis points (1 basis point is equal to 0.01%).

Academic research estimates that it contributed to high interest rates in the US during the early 1980s. Of course, rampant inflation during the 1970s also did.

That was a long time ago.

US short-term debt is now viewed as pretty much risk-free with investors demanding yields of just a few basis points to lend to the US government.

But, the immediate reaction to what looked like a technical default — literally speaking in the 1979 case — was for investors to become worried and demand more to lend to the US.

Now, investors are again worried.

The Hong Kong stock exchange has started to treat very short-term US debt, what's called Treasury bills or T-bills for short, as if they were no longer risk-free.

Some of the largest banks are beginning to do the same as they refrain from relying on T-bills as collateral for their transactions.

Even if the debt ceiling is lifted for six weeks as currently being discussed, investors are worried enough that they are also looking to exclude T-bills due to be paid in November and December.

Why it matters

Although this sounds pretty removed from you and me, the actions of these "market makers" matter.

By determining how much they would charge to lend to the US government, they help set the market rate for mortgages and business loans.

And in turn the US affects the world's capital markets because it has the largest so-called wholesale money market that banks and others rely on for financing.

Backing up a bit, investors that I have spoken to don't think that the US would default like Argentina did, where they just don't get paid or are paid a fraction after years of negotiating.

But, they worry about a lack of liquidity, which when translated means a lack of issuance of short-term debt by the US because the debt ceiling prevents the government from doing so.

The result for markets is that they would rather not rely on what they thought were highly tradable and "liquid" debt when it may not be due to prolonged political wrangling.

This is why yields or the amount that the US government has to pay to borrow rises because demand drops for these T-bills, with knock-on repercussions for all of us.

Coming back to the $6bn that is due on 31 October. It doesn't sound like a lot since the US produces about $43bn in output every day.

But, if the US misses a payment, then it would be considered a technical default because bondholders who are owed money don't get paid when they expect to. Even if that seems a bit technical and the US isn't Argentina, there are fairly notable consequences as I've described.

Plus, if the debt ceiling causes a loss of confidence in the US being the issuer of risk-free debt and that begins to weigh on the US dollar as the world's reserve currency, it would certainly be worrying if investors are unsure about whether the dollar will be a stable store of value.

The US dollar as the main currency used in international business is one of the reasons that the US has been able to borrow so cheaply.

Once creditors including the biggest holders of US debt like China and Japan begin to question it, it would be truly dire for America if it loses that "exorbitant privilege", coined by the former French Finance Minister Valery Giscard d'Estain, that has allowed it to enjoy low borrowing costs despite high levels of debt.

A prolonged political dispute would have lasting economic consequences as a result.

Linda Yueh Article written by Linda Yueh Linda Yueh Chief business correspondent

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  • rate this

    Comment number 61.

    The Chinese model is not sustainable.The US cannot continue to be a forever importing nation even if most of the profits are repatriated back to US corporations.Much of China's customers are also US workers who lost their jobs in the US when manufacturing moved to China. To restore stability, the US must repatriate jobs.It's the only way to balance the budget and distribute wealth acceptably.

  • rate this

    Comment number 60.

    The only way Fed creates money is by buying up US Treasuries. Only the Treasury can print limitless money. As the world's largest consumer nation the US should devalue its currency by printing much more and exit WTO imposing high import duties. This would force corporations who want to sell to Americans to manufacture here. Export driven economies like China and Germany will go into the dumpster.

  • rate this

    Comment number 59.

    This ~

    is just completly funny from many angles.

    Now Republicans Can't Even Agree On How The Obama Meeting Went

  • rate this

    Comment number 58.

    40. BluesBerry wrote: "Federal Reserve prints dollars; if they keep going, rest of the world is not going to accept dollars."

    Masterly put. That's exactly what so many Americans don't understand. Print dollars galore, devalue your foreign debt, and from then on carry out any import-export flow in dirham, leu, or krona.

  • rate this

    Comment number 57.

    If the US defaults, $6bn in unpaid on time debt will be the least of the world's problems. As a reference currency to which every established real and non real asset in the world is pegged, default would probably throw all financial markets into chaos. It's not the amount that matters. There's the US dollar and then there is......nothing else. There is no viable substitute waiting in the wings.

  • rate this

    Comment number 56.

    The good advice: no one should spend more than their income

    For everyone to have income greater than expenditure, extra new cash flows in, but from where?

    There has to be a 'source' that either creates it or invents it as debt. In the US, the Fed creates it and LENDS it to USGov

    Stop that and the source of cash that allows the rest of us to follow the good advice is no more - disaster

  • rate this

    Comment number 55.

    @45 Grounder

    Yes, I agree.

    Who will pull the plug first?

    Freezing the debt ceiling may focus minds.

    Short term benefit versus future sustainability.

  • rate this

    Comment number 54.

    The main point of this article is actually what happens when you turn, in this case by entirely artificial means, "risk Free" sovereign debt into ordainary debt, answer, roughly the same as in Southern EU States who constrained their ability to issue currency by adopting the Euro, borrowing costs go up, The EZ states at least had the excuse that there was no easy way to undo their mistake

  • rate this

    Comment number 53.

    @52 "What does a lack of new US debt issuance mean to financial markets?"

    If imports into the US hold up, it means more dollars chasing a declining stock of bonds, driving prices up and yields down. By substitution, US assets will be sought, driving markets higher. From lack of demand, dollar falls, making US exports cheaper and imports dearer, narrowing the trade deficit. What's not to like?

  • rate this

    Comment number 52.

    "But, they worry about a lack of liquidity, which when translated means a lack of issuance of short-term debt by the US....."

    First intelligent aspect of this story I have had from the BBC. What does a lack of new US debt issuance mean to financial markets?
    To simplify matters, let’s assume they continue to pay interest on what has been issued!

  • rate this

    Comment number 51.

    There is no such thing as "real money".

    Except you have to pay taxes with "real money".

    exactly people can despise the currency as much as they like but they still have to obtain enough of it to pay their taxes (some very rich people excepted) or end up in jail

  • rate this

    Comment number 50.

    #48. Remus

    There is no such thing as "real money".

    Except you have to pay taxes with "real money".

  • rate this

    Comment number 49.

    @19.Muppet Master
    You're falling into the trap of equating national debt to personal debt, The US has always had debt & unless there's a fundamental change in the capitalist system always will. Even if it permanently ran surpluses it would still have to issue debt for the system to function. Paying its debt off like a personal loan is not an option unless they revert to the Greenback dollar

  • rate this

    Comment number 48.

    There is no money involved. It is just electronic 'paper' that exists in cyberspace - it is not backed by gold reserves (like real money should be). Let the debt default, who cares?

  • rate this

    Comment number 47.

    Based on the fact, there seems to be no OTHER way to convince Obama he cannot continue to squander a trillion dollars every single year.......YES!

  • rate this

    Comment number 46.

    The USA cant afford to default, as it will cost them too much even in the short term. No one educated believes a default is in the USA's national interest.

    Its all gonna make some speculators a lot of money, all they need to know when the Politicians will back down. Follow profiteers and you will find the financial backers of the Tea party.

    "Democrazy" USA, just like the "Democrazy" UK.

  • rate this

    Comment number 45.

    @43 "Borrowing to pay interest on money already borrowed!"

    Hmmm... That's one way of looking at it... The key point is that the budget deficit is much higher than the interest payable, so there'd be more borrowing even with 0% interest. The extra borrowing to pay interest just makes the debt grow faster. At any positive rate of interest, an annual deficit must ultimately become unaffordable.

  • rate this

    Comment number 44.

    The dirty thieving US Bankstas were not satisfied with earning money the 'old fashioned' way - so they decided to manipulated spreadsheets until they were marketable - then sold junk swampland real estate as Beverly Hills Estates all over the world - Obama/Holder should have jailed them,
    like Bernie Madoff, rebooted, and we would have a new economy today
    As CiC, Obama fails - impeachment beckons

  • rate this

    Comment number 43.

    Borrowing to pay interest on money already borrowed!

    Is there really no downside to raising the debt ceiling?

  • rate this

    Comment number 42.

    @35.jack daniels esq,
    As in attacked by other major powers is what I meant.
    Shaving half a trillion off the US military budget would save a heap of money and still give them a larger budget than any other country, but wouldn't really change the landscape regarding terrorists other than the fact that the lack of a US military empire might incite less hatred towards the US.


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