Monday, April 25, 2011

US Default Could Be Disastrous Choice for Economy

The United States has never defaulted on its debt and Democrats and Republicans say they don't want it to happen now. But with partisan acrimony running at fever pitch, and Democrats and Republicans so far apart on how to tame the deficit, the unthinkable is suddenly being pondered.

The government now borrows about 42 cents of every dollar it spends. Imagine that one day soon, the borrowing slams up against the current debt limit ceiling of $14.3 trillion and Congress fails to raise it. The damage would ripple across the entire economy, eventually affecting nearly every American, and rocking global markets in the process.

A default would come if the government actually failed to fulfill a financial obligation, including repaying a loan or interest on that loan.

The government borrows mostly by selling bonds to individuals and governments, with a promise to pay back the amount of the bond in a certain time period and agreeing to pay regular interest on that bond in the meantime.

Among the first directly affected would likely be money-market funds holding government securities, banks that buy bonds directly from the Federal Reserve and resell them to consumers, including pension and mutual funds; and the foreign investor community, which holds nearly half of all Treasury securities.

If the U.S. starts missing interest or principal payments, borrowers would demand higher and higher rates on new bonds, as they did with Greece, Portugal and other heavily indebted nations. Who wants to keep loaning money to a deadbeat nation that can't pay its bills? (read more)