Last Wednesday, the US House passed a debt ceiling bill on a bipartisan vote. On Thursday, the US Senate passed the same bill, also on a bipartisan vote. On Saturday, President Biden signed the bill. A majority of both parties voted for the bill, but there was a significant bipartisan minority that opposed the bill. The opposition fell into two groups: those who wanted the bill to reduce spending more concretely, and those who did not want to reduce spending at all. Unsurprisingly, Republican opposition was in the former group and Democrat opposition was in the latter group. Ironically, those that voted against the bill are the same people that are most vocally against a US default.
The opposition Republicans want us to address our spending problem so that we never risk default in the future. The opposition Democrats want to stop having debt ceiling votes altogether so that the risk of default is delayed as long as possible. Either way, voting against the bill and triggering a default today would be equally unwelcome by both opposition groups, so it is good that their votes did not prevail.
No one is sure what a US default would look like. The US is in a unique position because the US dollar is the world's reserve currency. In some ways, the US dollar is like gold. Never before has a country in this unique position defaulted. But most economists and analysts, including me, agree that the results would be unpleasant. At a minimum, the US credit rating would be downgraded, and it would be more expensive to issue US debt in the future. Banks that rely on US debt may fail. More countries might consider non-US currencies for their primary reserve, which would further diminish the value of the dollar and cause inflation. Countries that rely on importing food from the US, like in Africa, would find that their US dollar reserves are worth less, which could lead to mass starvation. At worst, it could lead to war if a country, like China, becomes upset about the devaluation of its US dollar reserves and the US’s failure to pay the debts it owes China. In short, a default must be avoided.
Thankfully, we are not knocking on default’s door yet. In fact, we are probably a decade or two away from seriously risking default even if spending continues rising as it has for the last two decades. For instance, one measure used to analyze a company’s risk of default is the interest coverage ratio. This is a measure of a company’s income divided by its interest expense. It can be useful for analyzing countries, too. According to the St. Louis FED, in 2022 the US government’s tax income was about $3.181 trillion and the interest on the US government debt was about $0.710 trillion. Ignoring the relatively low cost of collecting the tax revenues, this gives us an interest coverage ratio of nearly 4.5. To put this into perspective, a company is generally considered healthy if its interest coverage ratio is above 2, so 4.5 is good.
We should not take this good news too far. The US may be reasonably healthy today, but the future is not going in the right direction. In particular, our entitlement spending is growing at an increasing rate. This means that every year, entitlements like Social Security and Medicare get more expensive and tax income is not keeping up. If this continues for a decade or two, politicians could pass all the debt ceiling bills they want, and it would not solve the problem. The new debt would cause our interest to increase and our interest coverage ratio to decrease until it becomes unhealthy and unmanageable. This will happen in the next couple decades unless we start enacting serious reform now. Fussing over comparatively minor discretionary spending once or twice a year is not going to cut it.
Defaulting on the debt today will not help because that is exactly what we want to avoid, and we are healthy enough today to avoid it. While the debt ceiling bill that passed last week is not ideal, it does enact some minor discretionary spending decreases and, more importantly, it circumvents a default crisis today. But to prevent the future default crisis that cannot be avoided with more debt, we need to get our legislators to start working on entitlement reform today.