August 1, 2011
By: Warren Beatty
Today we hear quite a lot about the U.S. debt ceiling or debt limit. So in this article I try to draw upon Internet news, political news, and economic news for sources to examine this situation. Before deciding about the politics of the debt limit, one must understand it – what it is, from where it came, and how Congress uses it.
Debt Ceiling ORIGIN, Composition, and Purpose
A statutory ceiling on federal debt was established in 1917 under the ‘Second Liberty Bond Act.’
The debt is the total outstanding liability owed by the US Federal Government to:
- U.S. Citizens
- Foreign Governments
The debt can be classified into two general categories:
- Public accounts, consisting of treasury bills, bonds, and notes
- Government accounts, owed by the federal government to itself, consisting primarily of Social Security and similar trust funds
The debt ceiling’s original purpose was an instrument established by Congress to limit the Treasury Department’s ability to borrow, but it has increasingly lost its effectiveness. It has been waived ten times in the last decade. And a vote to increase the debt limit has often been tied to “must pass” spending increases.
Debt Ceiling MYTHS
Here are some myths about the debt ceiling:
- Failure to pass a debt ceiling increase means defaulting on our debts – Refusing to raise the debt limit does not mean defaulting on our debts. The U.S. Treasury currently takes in more than enough revenue to pay both the interest and the principal on the debts we currently owe. The government would have to prioritize its expenditures – for example, sending out checks for the troops’ pay and Social Security first.
- Failure to pass the debt-ceiling increase on time would be unprecedented – Both the administration and the media sound as if we are at the edge of economic Armageddon if we have not raised the debt ceiling. That’s not quite so.
- It’s always a “clean bill” – The administration is insisting that it would be shocking for Congress to add any conditions to the debt-ceiling increase. But such conditions are far from unprecedented.
- This is not about future spending – The administration insists that raising the debt ceiling is just about paying for spending that’s already occurred. Depending on how high it is raised, it may be about paying only for spending that is already authorized – or much more. Authorized and spent are not the same thing.
- Only Republicans oppose raising the debt ceiling – The media and the administration want to turn this into a partisan fight. The ongoing narrative is that radical Republicans in thrall to the Tea Party want to wreck our finances, while Democrats responsibly want to pay our bills.
Debt Ceiling SCARES
Here are some scares that the administration and MSM try to promulgate:
- Treasury Secretary Timothy Geithner has warned that failing to lift the debt ceiling would have “unthinkable” consequences.
- Timothy Geithner said, [not raising the debt ceiling will] “shake the basic foundation of the entire global financial system.”
- Joshua Green, a senior editor at The Atlantic, wrote, “If Congress fails to raise the federal debt limit, the government will default, which all parties agree would have catastrophic effects on the economy.”
- The Associated Press reported that if “borrowing slams up against the current debt limit ceiling of $14.3 trillion and Congress fails to raise it, ‘the resulting’ damage would ripple across the entire economy, eventually affecting nearly every American.”
- When Democratic Senator Mark Warner of Virginia asked at a hearing what would happen “if we were to default and not raise that debt ceiling,” Federal Reserve Chairman Ben Bernanke replied ominously: “It would be an extremely dangerous and very likely recovery-ending event.”
When/If the Debt Ceiling IS raised, what happens?
In a release this afternoon (2 Jun 11), the Moody’s ratings agency said it would put the U.S. credit rating under review if Congress and the Obama administration don’t make progress on increasing the debt limit. “If the debt limit is raised and default avoided, the Aaa rating will be maintained. However, the rating outlook will depend on the outcome of negotiations on deficit reduction.”
The United States is at risk of having its pristine credit rating lowered if politicians in Washington cannot agree on a plan to bring down the nation’s deficits over the long term, ratings agency Standard & Poor’s said Monday (18 Apr 11). This means that there is a one-in-three chance that S&P could downgrade the nation’s “AAA” credit rating within two years. S&P said its outlook change was based on the growth of the United States’ deficits over the last several years as a percentage of gross domestic product, the broadest measure of economic activity.
Back in April, Standard & Poor’s threatened to reduce America’s top-shelf credit rating. Now another investment agency, Moody’s, has issued a similar warning. In fact, Moody’s is more urgent. S&P spoke of a one-in-three chance that our credit rating would take a hit within the next two years. Moody’s is talking about downgrading our AAA credit rating within the next few weeks. There is also a difference in the stated reasons both agencies gave for issuing their warnings. S&P was explicitly worried about our mounting national debt, while Moody’s is worried that we won’t make it bigger. This is an important warning shot fired by the credit market. Standard & Poor’s used a rifle, while Moody’s used a pistol. Raising the debt ceiling without budget reforms in place means we would dodge the Moody’s pistol shot and run smack into the S&P rifle bullet, which was fired to warn us of much more serious, long-term danger.
When/If the Debt Ceiling is NOT raised, what happens?
The United States has hit its debt limit on 16 May, 2011, and the world hasn’t come to a screeching end, the sky isn’t falling, and no one is really talking about it. The Obama Administration and Geithner have continually warned about a “double-dip recession,” yet, America is still in a recession and hasn’t gotten out of it. “Recovery Summer,” in fact was the opposite, the economy hasn’t recovered.
If Congress fails to raise the debt limit by August 2, the Treasury has only two options: It can default on its debt – meaning, stop paying its creditors around the world – or continue to pay creditors but halt any other federal spending above what the government collects in taxes. In effect, that would mean an overnight spending cut of about 40 percent. Here are six consequences if the Treasury is forced to choose one of those options:
- Cut $125 Billion Per Month – The federal government must borrow an additional $125 billion each month to finance all of its commitments. If the Treasury chooses to continue to pay creditors but stop all other federal spending, the government will have to begin reducing its spending by $125 billion every 30 days.
- Treasury Bonds Collapse – If the government defaults on its debt, economists say that prices for Treasury bonds would collapse and interest rates would probably soar to record highs.
- Cut Medicare and Social Security – To reduce spending by $125 billion a month, the government would have to make deep cuts to the two giant entitlement programs.
- Stock Market Plunge – Wall Street generally agrees with Geithner that it would be a disaster if the U.S. defaulted on its debt.
- Government Furloughs or Mass Layoffs – The federal government would most likely turn to furloughs or mass layoffs to immediately cut spending.
- Sky-High Mortgage and Interest Rates – If the government defaults, interest rates on mortgages would shoot up.
Dilemma and Debate
Current spending growth is unsustainable. The Government Accountability Office estimates entitlement spending on Social Security, Medicare and Medicaid alone will amount to more than 20 percent of GDP by 2080, if current policies are unchanged. Excessive government spending and high tax rates reduce economic freedom and thus the range of choices open to individuals. When government runs large deficits and adds to the national debt, private investment can be crowded out. Today, the gross federal debt is approaching 100 percent of GDP. In addition, unfunded liabilities of Social Security and Medicare total more than $100 trillion. Studies by leading economists Kenneth Rogoff and Carmen Reinhart have shown that when sovereign debt exceeds 90 percent of GDP, real growth tends to slow.
China, and others holding U.S. sovereign debt, will suffer huge losses if the United States cannot get its fiscal house in order and return to constitutionally limited government. By undervaluing the yuan against the dollar, China has accumulated more than $3 trillion in foreign exchange reserves, with a substantial amount invested in U.S. government securities.
For most of America’s history, adherence to the framers’ “Constitution of Liberty” did limit government spending, and the private sector flourished. Whether that ethos of liberty returns will determine the future path of U.S. fiscal and monetary policies.
Two of the biggest companies to warn of fallout from the debt-ceiling fight are life-insurance giant MetLife and private-equity powerhouse KKR. MetLife is brief in its warning, which appears in the quarterly report it filed May 10. It’s wrapped into a broader “risk factor” disclosure about “difficult conditions in the global capital markets and the economy,” and warns of market and economic volatility more generally. KKR is more specific. With its quarterly report filed on May 5, it added an entirely new section to its risk factors, warning of potential harm from a “failure or the perceived risk of a failure to raise the statutory debt limit of the United States…”
Financial firms aren’t the only ones worried about the debt ceiling. Hansen Medical, a small maker of medical robots in Mountain View, Calif., warns about the debt ceiling debate in its May 10 quarterly report. Seattle Genetics, a biotech company focusing on cancer and autoimmune disorders, warns of the debt ceiling debate in its May 6 quarterly report.
The debt ceiling is NOT the problem
The Treasury is out of money, but not out of games. Now that it has finally been made clear that in order to accommodate the debt ceiling by adding marketable debt, the Treasury has no choice but to literally plunder retirement accounts, we now know that in order to fit in the just announced $110 billion in new bond issuance over the next week, Tim Geithner will have to reduce US retirement funding (the bulk of which, the Social Security Trust Fund already lost $1.1 trillion in the past year) by at least $45 billion.
It should be noted that the debt ceiling is not the problem. Raising it solves the duplicity of Treasury behavior but doesn’t resolve the fact that we are caught in a debt death spiral that will result in the collapse of the dollar, producing hyperinflation and the likely collapse of our government.
Congress must accomplish three things to put the United States on a path to financial responsibility: (1) cut current spending, (2) restrict future spending, and (3) fix the budget process.
- Responsibility for the Debt Lies with Congress – When the Constitutional Convention met in Philadelphia in May 1787, the delegates who attended were well aware of the problems of the national debt, the state debts, and the poor financial reputation of the government. The Framers of the Constitution sought to reassure lenders that, even though it might change its form of government, the United States would honor its debt. The Framers included in the Constitution several other provisions that fixed responsibility for the national debt on the Congress of the United States. Legislative powers fix upon Congress the responsibility for the national debt.
- Congress Let Debt Get Out of Control – To spend more money than you have, you borrow, creating debt. Congress has grossly overspent beyond its means, creating a huge national debt. From a debt of $79 million when the Revolutionary War ended, the United States has racked up a debt of nearly $14.294 trillion. To put today’s debt in perspective, consider:
- It would take essentially everything that Americans produced (GDP) in all of last year to pay off the existing national debt of $14.294 trillion.
- The debt when the American Revolution ended was about $34 per American, which in today’s, inflation-adjusted dollars would be about $653 per American. Today, the debt owed by each American is over $45,000, nearly 68 times the size of the debt when the American Revolution ended.
Default on the debt does not occur when government borrowing reaches the debt limit. When the government reaches the debt limit and cannot borrow more money to pay its bills coming due, it must, as a practical matter in the absence of guidance set by law, establish priorities in paying the bills.
Congress should proceed with an orderly change of course in federal spending – taking action to cut current spending, restrict future spending, and improve federal budgeting – and at the same time it addresses the debt limit.
Failing to Control the Spending that Causes Debt, Congress Has Raised the Debt Limit Regularly – Early in the past century Congress enacted the first aggregate public debt limit, on federal bonds. Throughout the 20th century and into the present century, Congress has from time to time raised the debt limit and also has authorized the government temporarily to exceed the debt limit.
Fifteen weeks after the Japanese attacks on the U.S. territories of Hawaii, Guam, Wake Island, and the Philippines, Congress doubled the debt limit. Following the Japanese surrender on September 2, 1945, Congress took up the debt limit again -to cut it to $275 billion on June 26, 1946. Congress left the debt limit of $275 billion in place, but several times enacted legislation that temporarily authorized the government to borrow money in excess of the debt limit. Finally, on September 2, 1958, Congress raised the debt limit to $283 billion.
Since then Congress has raised the debt ceiling 30 times, and it now stands at $14.294 trillion.
- Cut Current Spending, Restrict Future Spending, and Fix the Budget Process – As federal borrowing approaches the current debt limit, Congress must reach agreement to accomplish three things to put the country on a path to financial responsibility.
- Cut Current Spending – In making cuts in current spending, Congress should emphasize cuts in continuing programs because, given the budget practices of government that look to existing budgets as baselines for setting future budgets, the current cuts likely will result in related reductions in future spending.
- Restrict Future Spending – In designing effective statutory restrictions on future spending, Congress should seek to reduce spending, with a reasonable transition period, to not more than the modern historical level of federal revenues.
- Fix the Congressional Budget Process – To do this, Congress should:
- amend existing federal laws that provide permanent or indefinite appropriations for federal agencies or programs (including entitlement programs), so as to retrieve congressional control of spending for those agencies and programs.
- estimate and publish the projected cost over 75 years of any proposed policy or funding level for each significant federal program.
- require a calculation of cost of a proposal that takes account of that response information available to Congress when it decides whether to pursue the actions.
WARNINGS from Europe – What could happen
- The European Debt Crisis – The “Vienna initiative” was a plan, drawn up in 2009, that halted the rot of financial contagion spreading through central and eastern Europe. It is now being discussed as a possible model for resolving Greece’s sovereign-debt crisis. The need to come up with a new plan for Greece is mounting. On May 20th, 2011, Fitch, a ratings agency, cut the country’s debt rating by another three notches. Yields on Greek ten-year bonds this week reached 16.8%, more than twice what they were a year ago.
- Greece’s Monetary Policy – Greece, struggling to avoid default on its massive national debt, obviously is in bad shape. This year it will run a budget deficit equal to 9.5 percent of its GDP. That actually is a significant improvement over last year, when its deficit topped 15 percent of GDP. Greece also provides an object lesson to those who believe that budget deficits are the result of low taxes. Greek taxes run as high as 40 percent on incomes above €70,000 per year. It’s not low taxes that caused the Greek crisis, but high spending. (Sound familiar?)
- Greek Coup? – Despite last year’s 110 billion euro Greece bailout there remains serious concern that the periphery EU nation will be unable to continue its debt repayments. Due to the increasing severity of the problem, and the ongoing resistance to additional support, the Central Intelligence Agency has now issued a report warning on how worsening Greek unrest could bring rise to even a military coup. A number of European Union countries including Germany, Finland, and the Netherlands have lost already lost interest in and support for extending any further bailout funds to Greece as its austerity measures continue to flounder.
- EU Safety Net Frays – “There can be no more illusions about getting help from the state,” said Ms. Gema Díaz, at home on a recent evening in a charmless, government owned complex on the outskirts of the city. Hers is a story repeated across Europe, fueling the protests and strikes that have tied up airports, blocked highways and, in Greece, even turned deadly. For millions of Europeans, modest salaries and high taxes have been offset by the benefits of their cherished social model – a cradle-to-grave safety net which, in the recent boom years, seemed to grow more generous all the time. Now, governments across Europe say they have little choice but to pull back on social benefits, at least for now.
- Greece, Ireland, Portugal Bailouts – It was a year ago that the European Union produced its big bazooka to quell the euro area’s sovereign-debt crisis: a €750 billion fund to safeguard the single currency, following within days of the €110 billion bail-out of Greece. It did not work. Ireland has since been bailed out, and a rescue of Portugal is in the works.
- Debt Ceiling Warnings from Europe – As the debate over America’s debt burden intensifies, Europe’s social and economic problems provide a warning to the United States. For over a decade, continental Europe has witnessed political and economic decline, culminating in a sovereign debt crisis which has brought the single European currency to its knees. What are the lessons from Europe on where the spiraling debt crisis will end? The Government in Britain has chosen to swallow the bitter pills of austerity cuts and deficit reduction. The Conservative-led coalition has pledged to eliminate Britain’s structural deficit by 2015, as well as to cut 490,000 public sector jobs. Sweden, which is also outside the Eurozone, has successfully steered its economy through this crisis. Having learned valuable lessons in the 1990s, Sweden’s center-right government has chosen to incentivize work and maintain budget discipline, which has led to economic growth of 4.5 percent in 2010.
Let us Americans analyze these different European approaches and what lessons they can offer America’s next presidential candidates. Politicians (of both parties) have only to look to Europe for a free, painless lesson about what awaits this country. But, as we (taxpayers) know, politicians tend to cling to their beliefs, even in the face of contrary evidence (Reid and Schumer come to mind).
But that’s just my opinion.
Crossposted at RWNO, my personal web site. Posted July 27, 2011; FloppingAces.net