Although the U.S. government has never officially defaulted on its debt, it missed payments on some Treasury Bills in 1979. Then as now, Congress was playing a game of chicken with Republicans and Democrats bumping heads on raising the debt ceiling. The debt limit was a fraction of its current levels and at the time, the dollar only fell briefly. The 0.6 percent drop in the Dollar Index was so small that it was barely left an imprint. However less than a month later, double digit inflation and concerns about the outlook for the U.S. economy along with the security of the U.S. dollar drove the greenback sharply lower. It may be tempting to attribute this decline to the short term default on U.S. debt but the Treasury started making its T-bill payments again after a very short delay.
Here’s a chart of how the dollar behaved when the U.S. government missed its debt payment in 1979
Treasury Secretary Geithner sent a special letter to every member of Congress today warning them that the U.S. could reach its debt limit as early as March 31st of this year. He said that if lawmakers fail to raise the debt limit, it could “precipitate a default by the United States.” As of today, the national debt stands at $14.01 trillion and growing, which is not far from the current debt ceiling of $14.3 trillion.
The debt ceiling is a cap that Congress sets on the amount of debt that the government can borrow. Although the debt limit has been raised 10 times since 2001, the debt ceiling is important because it helps Congress control spending. Each time the debt ceiling is raised, lawmakers are forced to actively assess the state of U.S. fiscal finances. If the debt ceiling is reached (and it never has been), the Treasury would not legally be permitted to borrow additional money.
The reason why this could “precipitate a default” according to Geithner is because the U.S. government funds operations and pays its creditors by borrowing. If they are unable to borrow, they are unable to make up the difference between what they spend and what they take in and if left unresolved this could lead to a default. Even a hint of default risk could cause rating agencies to downgrade their outlook for U.S. debt which would be enough to cause the dollar to nose-dive. For this reason, Geithner’s warning should not be taken lightly.