You may have heard some of the explanations of how the debt ceiling works and how it would be damaging to not pay the debts. While that is very true, there is another ominous danger of not raising the debt ceiling: that there will be a deficit of debt to purchase. On Chris Hayes' All In show last night there was an interesting discussion of the debt ceiling which hinted at the desirability of US bonds. And some Republicans point out that the US could probably pay for the interest and principal of the bonds. While sort of true, others point out that there would still be a form of default as many of the checks issued by the treasury would be returned with "insufficient funds" and rubber checks are a sure sign of bad faith. Even the dollar would then be suspect. Sounds bad? There's more.
What you haven't heard is the danger to the economy of the absence of new US bonds. Bonds/treasuries are about the most desirable form of liquidity. Like cold cash, US treasuries are as good as cash plus you get interest on them. Cash on the other hand often loses value with inflation. Everybody and their mother is invested in them, Wall Street, Social Security, China, Japan and Saudi Arabia to just mention a few. Even if the US treasury could pay all its bills, having a static debt ceiling is a danger to the economy.
Yes, you heard that right. Budget surpluses hurt investors. Sure there is a danger of too much US debt, especially since it sucks dollars from more productive parts of the economy. That is why the Federal Reserve is buying massive US debt (also known as quantitive easing), federal and mortgage, to increase the dollars in the more productive parts of the economy. There is much less danger of US debt due to the fear of not paying it off especially since the Federal Reserve can create US dollars and can also buy as much debt as the Congress creates. The danger is not running out of dollars to pay the bills, but that done to excess, the dollar will lose value to other currencies and be inflationary.
If you are still scratching your head, let me tell you of another time when the debt ceiling was not going up and there was a panic on Wall Street. During the first year of the Bush administration, and after a few years of surpluses, the US Treasury started to reach the point of not needing to issue more long term debt. And there was even the potential of an eventual cut off of any new debt issued. The Bush administration came to the rescue of Wall Street by reversing the years of surpluses and instead created massive new federal debt. Believe it or not headline from the New York Times from this time period, "Nothing Like Big Deficits To Hearten Bond Traders."
Although the increase in US debt helped Wall Street, the debt incurred did not improve the economy, because the Bush administration poorly spent the money. And the additional debt helped fuel the irrational exuberance that made the bubble even worse.
Here is a thought experiment. If the US zeroed out its debt (US has a cash accounting system), and did not need to issue more debt, should it anyway as a crutch for Wall Street and the global economy? If the balance of trade is negative, China and other economies park their trade surpluses in US treasuries. Investors like the liquidity, stability and sure return of bonds for portfolios. Not raising the debt ceiling is a danger whether or not the US can pay its bills. And this is a major reason that business minded Republicans will always support raising the debt ceiling and deficits generally.
Below is a link to a finance journal making a similar case.