Risk of a U.S. default has been exaggerated

By John R. Lott Jr.

A failure to raise the federal debt ceiling could "roil the financial markets and cause severe economic problems," "cause profound damage to our country," and have "dire consequences." So wrote the Los Angeles Times, the Washington Post, and the New York Times - in 1995.

Other ills predicted at the time were rising unemployment, reduced economic growth, and soaring interest rates. This was as President Bill Clinton and other Democrats were fighting off Republican attempts to link increasing the debt limit to cutting the budget deficit.

Then, as now, there was a widespread misperception that failing to raise the debt ceiling would lead to a default. The Washington Times reported that "congressional Republicans are threatening to provoke the nation's first-ever default." The Los Angeles Times warned of "the first real risk of a government default." Even Federal Reserve Chairman Alan Greenspan said Republicans should back down because, "To default for the first time in the history of this nation is not something anyone should take in any tranquil manner."

So what happened? After the government was shut down for five days in November, a temporary debt-ceiling increase was passed. But the government was shut down again for three weeks, starting in December 1995, before Clinton and congressional Republicans agreed on spending cuts and a long-term increase in the debt ceiling was enacted. Yet no default ever occurred.

In retrospect, that's not surprising. Default only occurs if the government stops paying interest on the money it owes. Not increasing the debt ceiling only means that the government is forbidden from borrowing more and that spending is limited to the revenue the government brings in. Interest payments, which amount to only a small fraction of federal revenues, are relatively easy to make.

Contrary to Democratic claims at the time, the shutdowns did not damage the economy. Unemployment remained constant during December 1995 and January 1996, and it fell slightly in February 1996. Quarterly growth kept chugging along. And stock prices continued to rise throughout the drama, with the Dow Jones Industrial Average gaining more than 6 percent between November and January.

U.S. Treasury bond rates, meanwhile, did not go up. To the contrary, they fell almost continuously during 1995 and early 1996. That indicates that, despite the warnings of politicians and the media, investors were not worried about a U.S. government default. If they were, they would have demanded higher interest rates to compensate them for that risk.

Investors today are showing similar confidence in the safety of U.S. debt. The contrast to the situation in some European countries, where default is a real prospect, couldn't be sharper. Interest rates have soared in such countries as Greece, Ireland, Italy, Portugal, and Spain.

Saying there wasn't a risk of a U.S. default then or now isn't denying that there is a huge and growing debt problem. And, yes, the shutdowns under Clinton had their drawbacks, including that some federal employees had to miss a paycheck or two - a significant problem for those with insufficient savings. (The lost paychecks were soon replaced, however, and those employees ended up being paid for not working.)

But we should remember that the fiscal standoff had long-term benefits. The budget battles of 1995-96 ultimately reduced the next year's deficit to only $22 billion. And the next four years saw budget surpluses, which few had thought possible before the shutdowns.

President Obama has continued to claim that a failure to increase the debt ceiling could mean a default. But his warnings of "Armageddon" are just scare tactics, as are Treasury Secretary Timothy Geithner's predictions of "catastrophic" consequences. We can only hope that members of Congress remember the lessons of the '90s and dare to vote for fiscal restraint.