Monday, April 18, 2011

Refusing to Raise the Debt Ceiling Would Be a Disaster

The need to address the fiscal crisis is one of the central beliefs of the Themistocles Letters. Indeed, we believe that the fiscal crisis is far worse than most people realize and far worse than our elected leaders will publicly admit. It is the great issue of our time. Nevertheless, refusing to raise the debt ceiling above its current level of $14.292 trillion (a level which will be reached within a month or so) would be a disaster. Our elected have a responsibility to hold their noses and vote for raising the debt ceiling, which also pursuing the policies necessary to get the deficit under control.

A bit of background is in order. Since 1917, Congress has set a limit of the maximum amount of public debt that the government can owe. As uncontrolled spending lead to ever-increasing debt, Congress continually passed new legislation raising this ceiling to higher and higher levels. To a casual observer, it might appear that refusing to raise the debt ceiling would be a good way of preventing the federal government from spending too much of the people's money. Indeed, Senator Mike Lee (R-UT), Senator Rand Paul (R-KY), and Senator Jim DeMint (R-SC) are even now publicly threatening to filibuster to death any bill that raises the debt ceiling. Senator Marco Rubio (R-FL), who has sometimes been touted as the "Republican Obama", recently declared in a Wall Street Journal op-ed piece that he will refuse to vote for a hike in the debt ceiling.

Refusing to raise the debt ceiling would be more than ill-advised; it would be disastrous. Indeed, since refusing to raise the debt ceiling would very quickly result in the United States government defaulting on its debt, it would be the fiscal and economic equivalent of a train wreck. The effects would be worldwide and catastrophic, making the credit crunch of 2007-09 look like a minor blip on the radar by comparison.

Those who say we should not raise the debt ceiling clearly have no understanding of how bond markets or the global economy work. The federal government borrows money by issuing U.S. Treasury bonds, and these bonds can be sold at a low interest rate so long as they seen as a safe investment. These low interest rates allow the federal government to borrow money at a comparatively cheap price (and, as a side effect, keep interest rates low on such things as mortgage loans). An appreciable chunk of the federal budget is already required every year merely to pay the interest on the debt we already owe; if the interest rates on U.S. treasury bonds went up, that percentage would be even higher.

Think about what would happen if the United States defaulted on its debt. They only have value because people buying them have confidence in "the full faith and credit of the United States". This confidence is rooted in the fact that the United States has never, in all its history, defaulted on its debts. If Congress causes a default by refusing to allow the debt ceiling to go up, U.S. Treasury bonds would plummet in value overnight. Investors around the world have long been concerned about the steadily deteriorating fiscal situation of the United States, and an actual default on its debt would cause them to dump U.S. Treasury bonds as quickly as they could.

The repercussions of this would be swift and devastating. If the value of U.S. Treasury bonds collapse, sovereign wealth funds, pension funds, and major mutual funds all over the world would also collapse, reducing millions of people to insolvency in the blink of an eye. Stock markets would plunge in value, bring the nascent economic recovery to an abrupt end and dragging the world back into economic chaos. Robbed of the ability to raise capital or safely invest their money, the industries which make the global economy function would stop operating just as surely as a car that has run out of gas. The economic damage caused by a default of the federal debt would be more akin to that of 1929 than that of 2007.

Even if the United States somehow got its act together after defaulting and begin honoring its debts once again, the long-term economic damage would be severe. Never again would U.S. Treasury bonds be as valuable as they had been before the default, for the "full faith and credit of the United States" would have been shown to be worth a lot less than had been thought. Investor confidence in U.S. Treasury bonds would be shattered, and it would take decades to repair the damage, if indeed it could be repaired at all. Investors tend to have a longer memory than politicians, after all.

Loss of investor confidence in U.S. Treasury bonds would mean that they could only be sold if they offer a far higher interest rates than they currently do. That, in turn, would make require the federal government to allocate far more money to paying interest on the national debt than it currently does, making the quest to restore some measure of fiscal sanity to the country all the more difficult. Of course, the global economic meltdown caused by the initial default would have shattered the American economy already, so perhaps this would be a moot point.

Is global economic chaos, the impoverishment of millions, and the shattering of the American economy a price that Senator DeMint and his friends are willing to pay merely to prove that they are serious about reducing the deficit? If so, they have no business being members of the United States Senate.

Many Republicans are currently calling for some sort of agreement in which they will agree to vote for an extension of the debt ceiling, but only in exchange for further budget cuts. This was acceptable up to a point in the recent debates about the remaining months of the 2011 budget, but it is not acceptable with the issue of the debt ceiling. If the markets become even slightly concerned that America will fail to raise its debt ceiling, it will damage American fiscal credibility. Indeed, Speaker of the House John Boehner has apparently been having discussions on the issue with top figures on Wall Street, who are trying to explain to him what the real world is like.

The Republicans are quite right to call for further budget cuts, but these are questions best left to the debate that will soon take place over the 2012 budget. Trying to tack them on to the question of the debt ceiling is playing with a kind of fire that could consume the global economy, and take America with it.

Congress should quietly vote to extend the debt ceiling and then move on to the debate over the 2012 budget. Can we hope that our elected representatives will act responsibly on this matter? Keep your fingers crossed.

3 comments:

  1. For way too long Congress has raised the debt limit anytime they wanted to pay for something new. Many times the new item was something they promised their constituents in order to get elected. This has resulted in an admitted debt of over $14 Trillion (Its $65 Trillion if you add in the unfunded liability to Medicare and what we will have to pay for Fannie Mae and Freddie Mac). This is prima facie evidence that our leaders will not stop spending money we don’t have. It has gotten so bad that S&P just reduced the United States Credit Rating from “Stable” to “Unfavorable”.
    I agree with your analysis that to default on our obligations would be disastrous. However, we must do something to force our congress and president to seriously address this problem. Senator Mike Lee (R-UT), Senator Rand Paul (R-KY), and Senator Jim DeMint (R-SC) Senator Marco Rubio (R-FL) are telling us that we have to get serious about fixing the debt before we can have any more. Perhaps an agreement from both parties and the President that the 2012 budget will reduce the deficit by $10 Trillion over the next ten years would be appropriate.

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  2. This problem has been brewing for decades, and will take a long time to solve. I agree that the ceiling should be raised, and the US should never default on it's obligations.
    However, we have been promised a solution to this problem for decades, and the problems have been exacerbated through corporate lobbying, (Thank the SC for removing financial limits on campaign finance), a tuned-out electorate easily side-tracked with irrelevant emotional rhetoric, and spineless representatives that lose the will to change the system as soon as they are elected to it. If you evaluated the proposals form both parties, they are arguing over $10 vs $14 trillion deficit increases. They have already missed the point!
    I don't fully agree with voting against the ceiling increase, but at some point, someone needs to say enough is enough. STOP the spending, NOW!
    In this case, my recommendations is to pass a BALANCED BUDGET AMENDMENT along with the ceiling increase, so our politicians are prevented from digging this hole in the future, and making the debt any worse.

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  3. This will be far worse than th 1929 Great Depression. China now owns half the Bonds the US will be defaulting on. 1929 was primarily a US economic disaster. This would be a WORLDWIDE CATASTROPHY financially destroying billions of people. Are our politicians really so stupid that they would risk World War III? Do they really believe China would not retalliate against us? This political posturing has already caused Banks and Corporations to take $5 Trillion Cash out of the economy preparing for the Default. That's how the very rich are protecting themselves. For the rest of us.......???????? GOD HELP US.

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