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The Debt Ceiling Isn't a Crisis   May 16th, 2011
Let's get past the hype       

 
QUICK OBSERVATIONS

More observations...
 

Many individuals--especially in the administration--have been promoting the idea that we must raise the debt ceiling or risk an economic collapse. While there are short-term risks, stalling on raising the debt ceiling would not necessarily provoke an Armageddon-like meltdown.

America is currently on a course for a debt crisis that will provoke a worldwide economic meltdown... but refusing (at least for awhile) to raise the debt ceiling is not the same thing and won't provoke the same economic disaster.

Choosing to Default

If Congress refuses to raise the debt limit, a conscious decision would still have to be made to default. Refusing to raise the debt limit will not automatically cause a default.

Our government currently spends about $10 billion per day, of which it borrows about $4 billion.

So if the debt ceiling isn't raised, that simply means the government would have to reduce spending by $4 billion per day (40%) until the debt ceiling is raised. If spending were reduced by that amount, we could still make our debt payments as scheduled.

That spending reduction could be accomplished by shutting down huge swaths of the federal government. An alternative would be to reduce all federal payments by 40% until the debt ceiling is raised--at which point the unpaid amount could be reimbursed to those that received reduced amounts.

The point being that we'd only default on our debt if the president made a conscious decision that he'd prefer to default on the debt than to temporarily scale back government. That would be an insane decision because if he left government running normally and the government was unable to pay a scheduled debt payment, the interest rate the government pays would immediately increase and buyers for U.S. bonds would disappear. Why loan money to an organization that isn't making payments?

So even if Obama decided to default, it would almost immediately cause the government to be unable to borrow money from the market and he'd still have to scale back government by 40% (unless, of course, the Federal Reserve went into hyperdrive and printed at least $4 billion per day to loan to the government, further undermining the dollar in the process).

The point here is that even if the debt ceiling is not increased, the United States will only default if President Obama chooses to default.

Sen. Pat Toomey is wisely proposing legislation that would compel the United States to give priority to paying its debt so that we wouldn't have to depend on this president making the right choice. After all, it's possible that the president wants to provoke a default on the debt. So it's good that Sen. Toomey isn't taking any chances.

Choice vs. Ability

The Armageddon-like collapse that I previously wrote about is what will happen if we continue on our current course. The day will come when, even if we continue to pay our debt, markets will be unwilling to loan us money at a reasonable interest rate. That's because the markets will increasingly be skeptical of our ability to pay the debt.

Right now there's no question we can pay our ongoing debt obligations. And if political gridlock freezes the debt ceiling, and even if Obama goes on an attempted economic suicide mission by intentionally defaulting on our obligations, the world will know we're still able to pay our debts. And there will be high confidence that we will soon make good on our obligations once we get passed the political struggle involved.

In other words, there's a huge difference between not being able to make a debt payment and missing a payment.

This is the difference between someone missing a $50 monthly credit card payment (i.e. can make the payment but ended up missing it, and will make it up next month) and someone that earns $10,000/year having a $500,000 debt (i.e. no reasonable expectation that they can ever pay the debt). If we refuse to raise the debt ceiling for a few weeks or months, we're effectively in the first situation. If we keep raising the debt ceiling without a fiscally responsible plan then we'll eventually be in the second situation. And that's where it would all hit the fan.

Consequences of Debt Ceiling Gridlock

My expectation would be that if the debt ceiling isn't raised and Obama chooses to default on our debt obligations, stock markets would tank, interest rates would spike, and precious metals would go up even higher. I'm certain it would rattle the world economy. But I believe these effects would be largely temporary.

Once the situation was resolved and our debt ceiling raised, markets would eventually return to normal. Of course the longer the debt ceiling is frozen the more damage would occur and the longer it would take for markets to return to normal. But whereas a full-on bond crisis could possibly be a non-recoverable event, the damage caused by a political struggle to achieve fiscal responsibility would be temporary.

And if the struggle resulted in a balanced budget amendment, the long-term impact could actually be positive as markets recognize that we're on track to get our fiscal house in order.

So hopefully Republicans will not be weak in the face of pressure to raise the debt ceiling. Failing to do so will not be the end of the economic world. But continuing to raise the debt ceiling without fiscal restraint eventually will be.

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