Raising the Roof
May 16. This is the date when the federal government runs out of cash, according to the Treasury Department. For obligations to be met after that, Congress must authorize an increase in the allowed national debt.
Timothy Geithner is taking action this week to buy a little more time; he’s suspending the issuance of special Treasury securities that subsidize states’ and localities’ infrastructure improvements. He has stated that he will take additional actions as we approach the Day of Reckoning.
I’ve talked about this before, but it bears repeating. Without an increase in that debt ceiling, the federal government will be forced to choose between two options:
- Default on the debt
- Shut down major portions of the government
Defaulting on the debt would have a disastrous effect on the US economy. Assuming the US would be able to issue any additional debt in the future, the interest rates for those bonds would be substantially higher than they have been historically. For the past century, there was no safer place to park money than in United States debt. This certainty translates into lower interest rates, because the reduced perceived risk leads lenders to feel no need for a risk premium (in essence, a higher rate includes a virtual insurance policy). If a default occurs, it will be at least several generations before that risk premium will disappear.
That higher perceived risk will also translate into a much weaker dollar, since the dollar will stop being used as the default (sorry) global currency. Just as the US debt has historically been considered the safest place to park money, so, too, have dollars themselves. The European Union, who has taken great pains to avoid any defaults of their own debt, will most likely become the economy of choice for safe parking, which would result in a dramatically stronger euro.
While I doubt that many in Congress are sincere about refusing to allow the debt ceiling to rise, I have no doubt that many in Congress see this as an opportunity to extort whatever concessions they’ve been itching for since the last budget battle a few weeks ago. And, given that our existing system rewards those who make long-term damaging decisions if they have short-term benefits, I also have little doubt that there will be significant saber-rattling about default as a means of showing how “serious” they are. If the only people who would be affected by this were members of Congress, I’d be fine with it. But it hurts all of us when they do this, because it changes the perceived risk of United States debt.
In other words, merely pretending that the US might default is enough to lead investors to start hedging their bets, translating into higher bond rates and a weaker dollar. The dollar is right now nearing its modern historical low point (which it reached two years ago), and this would almost certainly push it to a new low.
Why worry about a weak dollar? After all, it makes our exports more affordable, which should improve employment.
But a weak dollar hurts us in causing inflation in the one commodity that drives almost everything in our economy: oil. We’re already seeing some of those effects, which I warned about a couple of months ago in “Double Dip.” With gasoline prices firmly above the four-dollar mark, people’s behaviors are now beginning to change again, and discretionary spending is dropping. I’m going to go out on a bit of a limb here and predict that we’ll see worse earnings reports in the next quarter, particularly in the businesses that depend heavily on discretionary spending. Let’s see if I’m right. (This is one time I’d rather be wrong.)
I also mentioned before that we are looking at a cut of 43% of total spending, if we do nothing to raise the debt ceiling. To give a little perspective, that is larger than the entire discretionary budget. We could shut down all discretionary spending, and we’d still be left with some “mandatory” spending not happening. And, of course, we’re not going to cut the defense spending to zero. Or the FAA. Or many other agencies.
So we have to choose at that point what “mandatory” spending we will not make. Medicare? Medicaid? Unemployment insurance payments? We could cut all of those to zero, and cut all nondefense discretionary spending to zero, and that would just barely make ends meet.
I point all of this out to illustrate the absurdity of those who suggest that the debt ceiling can be used as a forcing function to solve the debt problem immediately. We don’t have a choice in the matter. We have to raise the ceiling.
And then work on solving the budget.
- Treasury Acts to Avoid Default (politicalwire.com)
- Why You Should Blame Tim Geithner, Not The GOP, If The US Defaults (businessinsider.com)
- Geithner Slips into Emergency Debt Limit Mode (news.firedoglake.com)
- Why We Won’t Inflate Away the Debt (theatlantic.com)
- U.S. to Take ‘Extraordinary’ Steps as It Nears Debt Ceiling (blogs.wsj.com)
- Geithner starts debt ceiling tap dance (money.cnn.com)
- Congress Receives Extension To Handle Debt Limit (huffingtonpost.com)
- Treasury Details Steps to Avoid Default (online.wsj.com)