The Debt Ceiling–what happens if the debt ceiling is not raised?

29 07 2011

I previously wrote about the debt ceiling.  In my first post about the debt ceiling I explained what the debt ceiling is and briefly touched upon the direct effects of not raising it.   I concluded with the only two clear conclusions that can be drawn:

“(1) we are not facing a total shutdown/Armageddon and (2) some people will be affected.”

In my second post, I gave the analogy of a credit card to explain that the Federal government “WILL still spend money, but only equal to the amount they bring in.”

In this post, I will step out on a limb and read the tea leaves to try to predict more direct effects from hitting the debt ceiling.  It is easy to say “we won’t have a total government shutdown” or “some people will be affected,” but it is much harder to say what the actual effects will be or who will be affected.  As with everything we post – this is not legal or financial advice, it is just a very brief, very rudimentary analysis.

The first thing to do is to start with what we “know” (I put “know” in quotes because I am getting this from the Wikipedia page on the U.S. Deficit, which is probably accurate, but I have not cross-checked this information with the official public reports):

(1) the Total debt is roughly $14.46 TRILLION, which is almost equal to the entire U.S. GDP in 2010.  GDP is not revenue (taxes are revenue).  Basically, GDP is the value of all goods and services produced in the entire country in one year.  It is important to note that U.S. GDP is calculated by adding together Consumption, Investment, Government spending, and net exports (which in turn is calculated by subtracting imports from exports).  There are different models of calculating GDP, but this is the one that is used to report U.S. GDP. 

(2) The 2010 deficit is approximately $1.6 TRILLION.  In other words, the government spent $1.6 TRILLION more than they brought in.  They had to borrow at least that much money.

(3) If the debt limit is reached, the deficit automatically becomes zero (because no further borrowing is possible).  The budget instantly becomes balanced.

From the above, we know that slightly more than 10% of GDP will be immediately taken out of the GDP calculation.  That’s a very large amount.  Directly affected will be government contractors – the government will no longer be able to pay those contractors, and that will have a trickle down effect.  Also, this will move the GDP number into recession territory.  Beyond that, it is hard to know who will be affected.

Since government spending is such a huge part of GDP, it becomes clear that the private sector is hurting and the government spending is masking some of that pain.  But that pain still exists in reality, it is just not reflected in the numbers.

So, from the above, we would expect the economic numbers to reflect a significant decline.  The people directly affected will be government contractors, and people in that chain.  It may also affect interest rates and the stock market, which then has ripple effects.

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