When does America run out of money?

Janet Yellen told congressional leaders that the federal government could run out of cash "as early as 1 June", turning the debt-ceiling standoff into an immediate problem for the plumbing of the financial system. The projected "X-date" is less than three weeks off, and the balance in the Treasury General Account (TGA) is falling fast towards $80 billion. Markets now have to ask a question that once seemed absurd: what happens when the United States government runs out of money? While politicians perform for the cameras, officials at the Treasury and the Federal Reserve Bank of New York are rereading confidential contingency plans for payment prioritisation.

In practice, prioritisation would be an administrative mess. The Treasury's Bureau of the Fiscal Service runs the federal payment system, which handles millions of automated transactions a day, from Social Security benefits and military pay to Medicaid disbursements and Medicare claims.

How the deadline crept closer

The government hit its $31.4 trillion borrowing limit on 19 January, and the Treasury has kept paying its bills since then with extraordinary measures, such as suspending investments in certain federal employee retirement funds. The Congressional Budget Office had estimated in February that those measures would last into the summer. Tax receipts in April came in weaker than forecasters had hoped, which is why the Treasury's own estimate has moved forward to early June.

The House of Representatives narrowly passed a Republican bill on 26 April that would raise the limit in exchange for spending cuts and the repeal of parts of last year's climate and tax law. The White House has said it will not negotiate over the ceiling itself. President Joe Biden is due to meet congressional leaders of both parties today, with little sign that either side has moved.

Choosing whom to pay

The Fiscal Service's computer systems were built to pay every valid bill automatically. Nobody designed them to pick, day by day, which legal obligations to honour and which to refuse.

The Treasury can technically put principal and interest on its bonds first and so avoid a formal default. Doing so would mean stopping payments to millions of citizens, federal employees and defence contractors. Switch off federal transfers at home and the economy would contract at once, and badly.

The arithmetic of paying bondholders is not the problem. Interest on the debt is a modest fraction of monthly tax receipts, and maturing bills can in principle be rolled over by selling new ones of the same size, which does not add to the total debt. The problem is everything else: once the cash runs out, incoming revenue covers only part of each day's obligations, and the rest simply goes unpaid.

What the Treasury planned in 2011

This is not the first time officials have faced the question. During the standoff of 2011, according to a later report by the Treasury's inspector general, officials concluded that choosing among individual payments was not practical and prepared instead to delay entire days of payments until enough cash had come in to cover them. That approach avoids picking winners, but it means every recipient, from pensioners to hospitals, gets paid late.

The 2011 episode ended with a deal on 2 August, and Standard & Poor's cut America's credit rating from AAA three days later. The downgrade came even though no payment was missed, which shows how little credit the agencies give for averting a crisis at the last moment.

Bondholders would still suffer

Paying bondholders first would not protect Treasuries from a downgrade either. The rating agencies have said plainly that holding back valid non-debt payments while paying creditors would be an institutional failure, and not the conduct of a AAA borrower.

Lenders in the repo market would demand much bigger haircuts on Treasury collateral as counterparties began to doubt that it would clear on time. Money market funds, which hold large amounts of Treasury bills, are already avoiding bills that mature in early June, and the yields on those bills have jumped above those on neighbouring maturities. The Fed has studied how it would treat delayed securities in its own operations, but no central bank plan can make a late payment on time.

The escape hatches

The strongest counterargument is that it will never come to this. Every previous standoff has ended with Congress raising or suspending the limit, and both parties know the political cost of a default would be enormous. Some lawyers also argue that the Fourteenth Amendment's clause on the validity of the public debt would let the president keep borrowing regardless of the limit.

Other devices have been floated before. During the 2013 standoff some lawyers argued that a statute allowing the Treasury to mint platinum coins of any denomination could be used to create a trillion-dollar coin and deposit it at the Fed. The Treasury and the Fed rejected the idea then. Any such trick would also need the central bank's cooperation, drawing the Fed into a fiscal fight it has every reason to avoid.

A last-minute deal remains the most likely outcome, and markets are right to assume it. The constitutional route, however, would invite an immediate legal challenge, and a Treasury bond whose legality is being fought over in the courts is exactly the sort of instrument that repo lenders would treat with caution. The signals to watch are the Treasury's daily cash statement, any revision to the X-date, and the size of upcoming bill auctions, which the Treasury must shrink as its room to borrow disappears.

Ms Yellen's 1 June deadline is where political brinkmanship meets the limits of the payment system. There is no tidy way to run out of money. If Congress misses the date, prioritisation will simply be the Treasury's name for an instant recession at home.