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If the debt ceiling talks fail, is August 2 really the drop dead date for a U.S. default?

Perhaps!

The President has said that the Congress needs a deal by July 22 to get legislation through Congress by August 2. I don’t buy it.

As long as a deal is struck by August 2, something can be patched together. However, the President and Treasury Secretary have so convinced most everyone that Treasury will be out of money by August 2, that a week before, interest rates investors demand on Treasurys may rise precipitously and the bond market routs. At that point, there may be no turning back.

It is unfortunate the President and Treasury Secretary are spreading around calamity scenarios, because the Treasury really does have options after August 2 if they don’t scare the markets into panic before then.

The Treasury will still be receiving 55 percent of its tax revenues and can easily pay the interest on the debt, and should then be able to roll over bonds coming due. For the balance of Federal expenses, the Treasury will have to prioritize, but it will have enough money for Social Security, Medicare and Medicare. Some checks may have to be spread out to accommodate discrepancies between payment dates and cash flows, but interest payments are modest enough, relative to the total cash coming in, that those can be met on time.

Selective payment of federal bills is possible—it was planned for government shutdowns when the Congress and President failed to approve appropriations—and it can be accomplished again if planned prior to August 2.

If no other sources of funds are found, the bond rating agencies have indicated failure to pay vendors and contractors on time would result in a downgrade in U.S. government’s AAA rating; that is likely to happen but a downgrade is not a default. As long as interest is paid on the bonds, the United States has not defaulted on the national debt.

A downgrade is likely no matter what comes out of current negotiations. Specifically, Standard and Poor has indicated a $4 trillion deficit reduction package is necessary by August 2 to avoid a downgrade. That simply is not possible given the President’s aversion to genuine spending cuts—evidenced by his failure to table concrete spending cut proposals—and the insistence on no new taxes by many members of the Republican House caucus.

Also, S&P is assuming a 3 percent GDP growth rate in projections of the future revenue, spending and debt to GDP ratios. Three percent growth is not likely to be attained this year or next without pro-growth reforms the President is ideologically opposed to accepting. This will all come to a head in February when the Administration publishes its FY2013 Budget proposal and 10 year deficit projections.