Right now there's a big debate in Washington about whether we should increase the debt ceiling or not. To hear each side of the argument, I believe the world will end if they don't get their way. What actually would happen if August 2 rolls around and there isn't a deal in place to push the debt ceiling up? Right now the government will only be able to afford 44% of its obligations in August if a deal is not reached. Here's my projection about what would happen. There's a lot out there, and some people like to say it's the Mainstream Media scaremongering us into acquiescence, but the fact is that there are very serious repercussions of hitting our limit and running out of money, so to speak. Our choices would be as follows: pay the social obligations (Medicare, Medicaid, Social Security). Pay interest on the debt, some government, and the troops. Pay some of each. Here's what would be most likely, just based on common sense. Of course, common sense says to stop the showdown and make a deal, so here we are.
August 2: All non-essential government personnel are furloughed. The Departments of Education, Energy, Interior, Transportation, Health and Human Services, and Agriculture are shuttered because there is no need for them to stay open as they will not be processing any outgoing funds. National Parks are closed. Airlines and airports are forced to pick up the tab for TSA or else cancel flights. They do in hopes that things will resolve soon. Interest rates on US debt (and thus on credit cards, mortgages, car loans, and any other loans originating in the US) begin their long climb higher. The US loses it's AAA credit rating.
August 3: Social Security checks are withheld. This is the only possible option. To do anything else would be even more catastrophic. This means that millions of seniors who are living hand-to-mouth run out of money. 15% of seniors depend wholly on their Social Security to survive. They would be forced to food kitchens or other options out of necessity. Additionally, to make things worse for them, the government stops Medicare checks to providers. This includes hospitals, nursing homes, hospice, home health care, and every other segment of our health system. Because these companies cannot shoulder the burden for long, every senior getting health care is on borrowed time. By the end of the month, thousands of health care workers are let go and millions of seniors no longer get health care.
August 15: Interest rates on the 10 year T-Bill (currently at 3.125%) are at 15%. With no end in sight, the Treasury department tries to roll over $500 billion in maturing debt. Existing bondholders, concerned that they will take on too much risk by participating are lured in by higher interest rates. A spike in rates to 20% costs the government trillions and leads to a massive selloff in stocks. The Dow drops from 9,000 to 7,500 in just a few minutes, wiping trillions of dollars of value out of the market. The dollar drops to an all time low against the Euro, hitting $1.75/euro. It likewise falls against every major currency in the world. Meanwhile, the housing, auto, and lending markets lock up as consumers are unwilling to pay the interest rates. This causes a massive selloff in financial stocks, leading to the collapse of Bank of America. Because the government is unable to use any funds to pay FDIC insurance or drive BofA into another bank's arms, millions had their life savings wiped out in the blink of an eye. The US credit rating descends to Junk status, below that of Greece, Portugal, and Ireland.
August 20: Hundreds of thousands of protesters gather in Washington DC demanding an increase in the debt ceiling. These protests start out peacefully, though anything could turn it into a powder keg. The state of Texas announces its plan to float its own currency. It is in negotiations with several other states on how to bond together to protect their citizens
August 25: The Dow is at 6,000. Major corporations announce their withdrawal from the US market. Due to unrest and uncertainty, over 1 million illegal immigrants have left the country. This leads to a lack of labor for the upcoming harvest. By the end of fall, millions of pounds of food will have rotted in fields. The dollar went below $2.00/euro. Gold is over $2500/oz and silver has skyrocketed to $60/oz. Oil prices have skyrocketed due to the currency fluctuations and currently stand north of $200/barrel. This has led to gasoline prices over $7.00/gallon in some places. People have abandoned their cars in many places because they can't afford to fill their gas tanks. The combination of people out of work and no credit has impacted every aspect of American life. American Airlines went out of business. The combination of record high oil prices and having to pay for airport security was too much for the venerable company. Delta, United, Southwest, and US Airways have drastically cut schedules as they cannot afford to fly and neither can the public. What started as a peaceful protest in Washington has descended into something more akin to anarchy. On the third day some protesters got violent with Capitol Police. The police struck back in self defense, but that incident led to the National Guard being called into service. Because of the situation in the country, they were only able to get half as many troops called up as they anticipated. President Obama will address the nation tonight from an undisclosed location and declare Martial Law will be in effect, along with suspension of habeas corpus until things have calmed down. Congress is said to be within hours of finally brokering a compromise package that has become dramatically bigger than was previously necessary due to interest rates compounding the debt crisis. This package includes drastic cuts in government spending and large tax increases on the wealthy. It is estimated to save $4 trillion over 10 years. Meanwhile, the budget deficit is projected to increase from $14 trillion to $28 trillion due to increased borrowing costs during that time.
August 31 - President Obama signs into law a debt ceiling increase of $4 trillion dollars. The markets have stabilized on the news with the Dow at 5000, the S&P at 500, and the dollar bottoming out at $2.10. Meanwhile, yields on T bills are slowly dropping back to earth. They will slowly drop from their peak at 35% and end up at around 15% over the mid term due to the increased instability that our new credit rating implies. We have our agreement, and it only took erasing $10 trillion in assets to do it.
August 2 - President Obama, invoking the 14th Amendment, declares the US debt limit has been raised to $18 trillion. Congress immediately sues. As the case winds through the courts, credit markets are soothed. The case makes its way to the Supreme Court, where President Obama declares that he will follow FDR's path - if the Supreme Court doesn't see things his way, he will immediately appoint 6 new justices to the court. Chief Justice Roberts sides with President Obama's interpretation. His leadership will get him reelected in 2012 by a landslide. Meanwhile, Congress passes back into Democrat hands as the tea party members of the Republican party are defeated in an historic fashion.
July 22 - With hours to spare, the two sides make a deal that involves spending cuts and some tax reform. The economy is spared and life goes on as normal.
I know that some of this may seem outlandish, but something to remember is that when Lehman Brothers went bankrupt, we plunged into the Great Recession. That was an investment bank. This is the largest economy on Earth. It's a matter of scale, and this is not at all out of the question. It may be a more worse case scenario, but it's definitely not out of the realm of possibility. Unless the two sides realize that they need to broker something so both sides can win, one way or another, everybody loses.