The Debt Limit
To get the preliminaries out of the way: A default would be a very bad thing. The Republicans are being stupid, but so is Obama for refusing to sign a temporary measure. If you want a smaller government, the best way to do it is to reduce spending by eliminating ineffective government programs. Going back and refusing to pay your bills just raises interest rates and causes a higher cost of financing the debt resulting in higher taxes in the long run.
Nothing I can tell you about the politics will be more interesting than what others have already said on this issue, but I want to run over a few scenarios where default can be avoided.
Order the Fed to destroy bonds
The whole idea of the Fed “owning bonds” is a gimick anyway.
“The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned.”
The debt authorized by law shall not be questioned. So legal debt shall not be questioned, but does Congress authorize debt when it sets a tax rate and spending rate (the deficit is endogenous to those two variables), or does it authorize debt when the debt ceiling is raised? If Obama tells the Treasury to pay anyway, Republicans in Congress could take him to court, but it would buy some time.
The long run effects might include a bit more inflation than otherwise, but honestly we could use inflation right now, so I see pretty much no short run downside to this option right now.
Overdraw Fed account
You can, why not the Treasury? Do you really think Bernanke is going to bounce Obama’s checks?
It’s stupid to even be talking about this when 30 year treasuries are under 5%. Clearly the market doesn’t think our debt is either risky or unsustainable.