http://www.americanthinker.com/2011/04/do_we_really_need_to_raise_the.htmlIn the last week I've read at least four syndicated columns which contained the following argument: were the Congress to resist raising the debt "ceiling," the full faith and credit of the United States Government would be endangered. The financial system would inevitably crash; investors would send their capital to other safer, more stable havens; depression would follow. Since I am an inveterate skeptic, I feel we must investigate this calamitous premise a bit before accepting the conclusion that the debt "ceiling" must be raised.
To predict the outcome of not raising the debt "ceiling," let's model the nation's current economic morass, and try to predict the outcome. For our study we will consider an American household, since that is a financial model most of us can comprehend.
Let's say the household has two working adults and two children, a home with a mortgage, two cars with one car loan, and some credit cards. Their debt (between the mortgage and the car loan and credit cards) is very high compared to their income, and their "nondiscretionary" expenses such as food, and utility bills cannot be easily reduced. They have another expenditure category which we will describe as "discretionary," comprised of clothing, entertainment, eating out, pursuing hobbies, vacations, gifts, and other non-mandatory expenses. In order to pay their expenses each year, they pay more and more of their total outlays via credit card, because they spend annually approximately 40% more money than they earn. Despite making their payments on time, they cannot pay off any of the credit cards and in fact the principal increases steadily. Each year they have an annual budgeting meeting where Mom and Dad debate contacting their credit card companies and requesting a credit limit increase. They acknowledge they should spend less, but they don't know how to cut back. Therefore they keep spending, they increase the portion of their income dedicated to interest and debt payments, annually increase their credit limits, and keep incurring more and more debt. This situation is comparable to the one faced by our government right now, the result of decades of bad management, bad planning, political payoffs, and influence peddling on the part of our leaders, and a combination of greed and apathy on the part of the governed.
One aspect in which the government differs from the household analogy is that the government can print currency to pay expenses and reduce the value of the public debt. This ability complicates the picture, but usually results in a net loss: it punishes those who save, and reduces the value of the dollar. Ernest Hemingway said, "The first panacea for a mismanaged nation is inflation of the currency; the second is war." Massive inflation of the scale necessary to pay down our current debt (over $14 trillion) would certainly lead to war, either with foreign creditors or ourselves, or both. If we put aside the flawed tactic of inflating our way out of debt we can analyze the promise of raising the debt "ceiling" as we set out to.
What would happen in our model if the debt "ceiling" were not increased? In other words, in one particularly contentious year, Mom and Dad do not agree to request a credit limit increase from the credit card companies. Mom says, "We must request a credit line increase! If we don't, our credit will be destroyed! Our cards will be revoked! We'll go bankrupt!" Dad disagrees, advocating instead for cuts to both spending categories until the family can live within their means. His option sounds painful because it would force the family to make substantial interest payments on debt even while not enjoying the benefit of the credit cards, and to live on a fraction of their income while paying the debt service resulting from years of overspending.
It appears to me the Mom's claims pretty closely match those trumpeted in the press and by the political leadership of both parties. Are they true? Maybe we can't know for sure, because no one fully understands the incredibly complex financial system, and no model can take into account billions of independent decisions. But are they reasonable predictions? Let's consider them one by one.
"Our credit will be destroyed." Credit is a quantification of one's borrowing power. We can consider it to be the willingness of creditors to lend money, or the willingness of investors to buy bonds. Would this willingness be adversely affected if the US did not raise its debt "ceiling"? If the household in our model continued to pay its current obligations, there is no means by which its credit could be negatively impacted. Lenders would not reduce their willingness to lend to the example household. If anything, Dad's recommendations would be seen as a sign of fiscal discipline and maturity, increasing the household's favorability with lenders.
"Our credit cards will be revoked!" This is analogous to saying we would not be able to make emergency purchases or borrow in the future if we need to. However, if the household continues to make its payments on existing debt, there's no reason a reduction in borrowing power would occur. On the contrary, if the US stopped buying bonds, and continued paying her existing debt obligations, investors would be very willing to buy bonds (demand) while the supplier would be less willing to sell bonds (supply). Basic economics would then force the transaction to become more favorable to the supplier (which means the bond rate would go down), making it ever more attractive for the government to sell bonds in the future. Bonds would be perceived to be an incredible stable, reliable investment because the borrower demonstrated discipline. This would represent an increase in borrowing power for the government, not a decrease.
"We'll go bankrupt!" Bankruptcy occurs when it is not possible for an entity to make the debt service payments on existing balances. We are not far from such a point already, but to say that increasing our debt "ceiling" would be a prophylactic against this outcome is ludicrous on its face. Imagine a judge telling a bankruptcy plaintiff, "You don't need bankruptcy protection. Just borrow more money to pay your debts." Again, as long as the household (or government) continues to pay its debt obligations, there is no need for bankruptcy (or insolvency, or war with foreign investors). But the threat of insolvency does point to the absolutely dire need to drastically cut expenses and stop financing day-to-day operations with more debt.
Not one of these apocalyptic claims made by proponents of raising the debt "ceiling" makes any sense. The first two seem to be the opposite of what would reasonably be expected; the third seems to argue against more debt. All of the scary scenarios presented to make us fear a fixed debt ceiling could in fact only come about if we stopped making debt payments -- which is to say, if we continued spending on vacations but defaulted on our interest payments.
I am not saying there would be no negative effects of treating our current "ceiling" like a ceiling. The measures necessary to cut non-debt expenditures to levels consistent with revenue would cause some severe shocks to the economy; industries and individuals which survive only through government largess would be painfully rearranged. Investors do scare easily, so they might panic after seeing difficult cuts, perhaps thinking the cuts might signify coming defaults on bond debt. This effect should be short-lived, however, since steady payments on debt obligations would outweigh the initial frenzy.
In addition to fear in the bond market, many people would lose their jobs. Many government services would be interrupted. A difficult but absolutely necessary prioritization of federal spending would be imposed upon a congressional leadership unaccustomed to restraint. The unions, the lobbyists, the contractors and sub-contractors, the foundations, and the non-profits would go to surprising lengths when threatened by the loss of federal funds. There would be immense political pressure to continue to fund lesser priorities with more debt or with inflation, and massive infighting between cash recipients.
Whatever the difficulty, we must stop treating the debt "ceiling" as a debt target, or our fiscal condition can only deteriorate. History has shown tax revenues to be very consistent at about 20% of GDP. The ratio implies we should do everything possible to reduce spending to less than 20% of GDP, eliminate obstructions to GDP growth, stop borrowing immediately, maintain the debt "ceiling," and continue to pay our debt obligations. If we fail to do these things, the debt payments alone will come to exceed our revenues; at that point there will remain precious few options, and all of them will be far worse than the path of discipline we could choose today.
Topic: Do We Really Need to Raise the Debt Ceiling? (Read 1520 times)