WHEN big chunks of America’s federal government suspended business on October 1st markets mostly yawned. Although the “shutdown” was the first in 17 years, the political dysfunction that caused it has become the norm in Washington, and the economic consequences are slight. Nerves are now beginning to fray, however, because something far worse looms. On October 17th the Treasury will run out of ways to sidestep the limit Congress places on the federal government’s debt and so will no longer be able to borrow.

As a result it could, within weeks, be unable to pay some bills. Whether this would mean defaulting on its bonds, and thus throwing financial markets into chaos, is unclear. But the prospect is causing jitters. It is becoming more expensive to insure against an American default using credit-default swaps (see chart). Meanwhile, the Chinese government, among others, has urged America not to let its partisan paralysis infect the world economy.

The fear is that amid the political brinkmanship, the Treasury will miss an interest payment on some of its debt, in spite of the fact that America is perfectly solvent and should have no trouble paying its bills. That would play havoc with the global financial system, which depends heavily on American government bonds as a common, liquid and—hitherto—safe asset. Over $500 billion-worth change hands every day. They constitute a big share of the collateral that banks around the world put up to secure short-term funding. If America defaults, lenders may refuse Treasuries as collateral because they could not be sure that anyone else would accept them, says Michael Cloherty of RBC Capital Markets. That could trigger a cash crunch and a spike in demand for alternative collateral. Financial institutions might start hoarding funds, causing markets to seize up.

For now, such a calamity is not the likeliest outcome. Both sides want to raise the debt limit before the deadline, perhaps as part of a deal that ends the shutdown as well. One possibility is that Congress raises it by a small amount to allow further negotiation over the budget and health-care reforms.

In the meantime, the shutdown is doing little damage. For one thing, it applies only to the third of federal spending that Congress has to reauthorise each year. The rest, including interest payments on America’s debts and outlays on Social Security (government pensions), Medicare (health care for the old) and most government assistance for the poor, carries on as usual. In addition, functions that fall within the affected third but are deemed essential, such as defence, air-traffic control and disaster assistance, not to mention Congress and the White House, are exempt.

Economists initially reckoned each week of the shutdown would trim 0.1 to 0.2 percentage points off America’s annualised growth rate in the fourth quarter, thanks chiefly to the forgone pay of roughly 800,000 idled federal employees. However, estimates of the damage done have dropped by as much as half since the Department of Defence recalled most of the 400,000 employees it had put on leave without pay and the House of Representatives voted to make good the losses of other civil servants.

Those pay-cheques will be in jeopardy again if the debt ceiling is not raised. Increases used to be routine: after all, Congress regularly approves budgets that include deficits and thus, arithmetically, lead to a higher national debt. But if Congress remains obdurate, the federal government will have to renege on some obligations. The Treasury hit the current ceiling of $16.7 trillion on May 19th and has since used book-keeping manoeuvres to keep issuing debt and paying bills. On October 17th, it says, it will have exhausted those tactics.

It will still have $30 billion of cash on hand, and will continue to collect taxes. But it will soon struggle to make several large payments: $12 billion for Social Security on October 23rd, $6 billion in interest on the debt on October 31st and $67 billion in payments for Social Security, Medicare and bureaucrats’ and soldiers’ salaries on November 1st. By that date, analysts reckon, the Treasury will miss a payment on something.

But it may not be on the debt. Many analysts, including Moody’s, a credit-rating agency, believe that the Treasury will ensure that interest is paid before other obligations. The Treasury has suggested it does not have the technical ability or legal authority to prioritise one payment over another. It would be awkward, naturally, for politicians to argue that old, poor and sick Americans should forgo their government benefits so that foreign bankers and governments can continue to earn interest on their huge holdings of Treasuries. Picking among the many deserving Americans owed money by the government would be almost as hard.

Even if America does pay the interest on its debts, the economy would not be saved. To eliminate its deficit instantly the federal government would have to slash spending by 4% of GDP, assuming interest payments are made, according to JP Morgan Chase, a bank. If sustained, that would be enough to bring on a recession. Unlike with a shutdown, nothing would be spared: pensions, health care and military salaries would all be vulnerable.

If by choice or miscalculation the Treasury does miss an interest payment, it might not suffer as much as the rest of the financial system, in the short run. In theory, a default should cause the price of Treasuries to plunge and interest rates on new issuance (if and when it resumes) to soar. However, if default triggered panicked sales of stocks and other assets normally seen as riskier, the result might in fact be a rush into Treasuries. There are no “cross-default” provisions on Treasuries, which means that missing a payment on one does not automatically place the others in default. This, combined with the lack of ready alternatives, may deter banks, mutual funds, and sovereign-wealth funds from mass selling.

Nonetheless, a default would do lasting damage to the government’s finances. “What sets Treasuries apart is the fact that holders can turn them into cash at a moment’s notice either by selling or pledging them,” notes Wrightson ICAP, a broker. “Once Congress establishes the precedent that debt-service payments can be delayed on a political whim, Treasury securities will no longer be immune from liquidity risk.” America would have jeopardised the “exorbitant privilege”, as a French minister once put it, of borrowing in the world’s most trusted currency.