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.