Treasury will always be able to make its debt payments

By Felix Salmon
July 27, 2011

I’m not sure where this meme originated, but people are saying with great confidence these days that Treasury has to borrow money just to pay the interest on the national debt. It simply isn’t true.

Here’s Michael Kinsley, last week:

Nobody knows for sure what will happen if Aug. 2 arrives with no deal made. But there’s good reason to expect the worst. The U.S. has fallen into the classic debtor’s trap of borrowing to pay the interest on previous borrowing. This means that even if we shut the government down completely, bills would still be coming in and interest payments would still be coming due, and we’d be unable to pay them.

And here’s Chris Wilson, today:

Here’s one way to express how catastrophically screwed the U.S. government’s finances are: If the entire U.S budget were cut to zero, effective immediately—the military, all entitlements, the electricity bill for the Capitol—there still wouldn’t be enough money to cover the payments on old debt that come due every day.

The fact is that Treasury can easily cover interest payments from tax revenues alone. We raise about $180 billion a month in taxes; interest payments come to about $30 billion a month. If the government shut down completely and did nothing but collect taxes and pay off the national debt, it would be running a profit of a good $150 billion a month.

Which is why I’m pretty confident that we’re not going to suffer a payment default on Treasury bonds. They’re called Treasury bonds for a reason: they’re issued by Treasury, which ultimately is going to make the determination about what payments to prioritize if the debt ceiling isn’t raised and we run out of money. Given the catastrophic consequences of a payment default on Treasury securities, those bonds will always have first priority — even if that opens up the White House to accusations of treating Chinese bondholders better than our uniformed military.

One confusion here might surround the difference between principal and interest payments coming due. When a principal payment comes due, that can be a huge amount of money — but when a bond is paid off, the national debt goes down by that amount. As a result, you can roll over the debt by issuing new securities, and not breach the debt ceiling. It’s only the interest payments which matter, unless the markets start refusing to roll over US national debt. And there’s no chance of that happening.

So when people talk about a US default, the reality is that the US is not going to make a payment default on its bonded debt. Instead, there will be other, weaker forms of default. The US sends out 200 million checks a month, and all of those are government obligations of one form or another. They’re not debt, in the way that Treasury bonds are debt. But they’re obligations all the same, and market confidence would indeed be rattled if the government found itself unable to make good on them. But that kind of confidence-rattling is nothing compared to what would happen if Treasury bonds started going into default.

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