Our elected officials in Washington, DCare embarrassing themselves, and those of us who voted for them…again.
What is it about human nature that causes us to reach the point of brinkmanship? Rhetorical of course, though here we are again witnessing our elected representatives taking a policy decision down to the wire. Only this time, it really is serious, unlike the 2009 Christmas vote on Obamacare.
While government finance and accounting can quickly get very complex, the basic problem we are confronted with is not. Government revenues, in the form of taxes and fees, are out of balance with government expenditures for national defense, international affairs, health, Medicare, income security, Social Security, net interest, and a litany of smaller programs.
In order to correct the imbalance, the choices are simple.
1. Raise revenue and keep expenditures constant
2. Keep revenue constant and cut expenditures
3. Raise revenue and cut expenditures
4. Use gimmicks, extrapolation, adjust cash flows, play games
At the moment the federal government is running annual budget deficits of between $1.3 and $1.5 TRILLION. In the 67 years since 1944, the federal government has only run a yearly budget surplus in 12 of those years. As a result, we find ourselves up against another legally established debt ceiling of $14.3 TRILLION.
Every year we spend more than we take in, the debt rises. In order to first stop further increases in our national debt our next fiscal budget must at least be balanced: revenues = expenditures. In order to begin to reduce our national debt, we must have multiple years in a row where revenues exceed expenditures.
This is serious stuff. This is the pinnacle of policy formulation. Brinksmanship is not welcome now. Formulating policy under the pressure of the clock will not bring the best results. Our elected representatives have failed, time is up.
Default on Treasury bond interest payments or principle payments cannot happen.
As regards America’s AAA credit rating, as established by private sector financial companies (Moody’s, S&P, Fitch), it is a proud emblematic sign for patriots to hold up. That America faces a downgrade is yet another shot at our national pride and patriotism. Even though these same rating agencies rated bundled up sub-prime mortgages AAA, that hasn’t tarnished the perceptions of their judgments when it comes to national debt, be it Greece, or the USA.
The real kicker beyond our wounded pride when it comes to losing our AAA rating is that many mutual funds, hedge funds, money market funds, sovereign wealth funds (foreign government money invested here, think China), are only allowed to invest in AAA rated financial securities. Losing the AAA rating will result in significant legally required repositioning of portfolios out of US Treasury bills, notes and bonds. This will be one of the catalysts for higher interest rates along the yield curve (plotted interest rates from over-night rates to 30 year T-bond rates).
Any potential downgrade will likely be less meaningful if we increase the debt ceiling without cutting spending than if we default on interest or principle bond payments.
Given the repeated failure of Republicans and Democrats, and the now late hour, the proper economic advice as of July 28, 2011 is to halt all negotiations over a 10 year budget deal, and just raise the debt ceiling by $1.3 trillion. The language for such an increase should include the requirement any additional debt ceiling increase would require a two-thirds vote of both the House and the Senate.
Then, since the federal government is running on a continuing resolution (short term funding of government in absence of a budget), beginning on August 1, 2011 start the required work of the Congress on formulating a budget for 2012 that results in a balanced budget. Once that is in place, begin negotiations on cutting our national debt over the next 10-15 years. Naturally, in order for that to happen expenditures for Medicare, Social Security, and Obamacare will have to be cut.
What happens if we don’t pass an increase in the debt ceiling by next Tuesday?
Short-term financial market volatility will spike; interest rates will rise, stocks will fall, the US dollar will be whipsawed about, and the media will be in a frenzy. However, we will quickly discover the world won’t end. America will still be here, and be the top dog. Moreover, we will be reminded the US Treasury takes in on average approximately $180 billion a month, enough to to pay some of our most important bills, like:
$59 billion per month for Social Security
$58 billion per month for National Defense
$38 billion per month for Medicare
$17 billion per month for Net Interest
After that, we’ll still have approximately $8 billion to fill in critical holes. (note: revenues into the Treasury don’t all flow in on the first day of each month. Revenues in per month are not as legally smooth as expenditures going out per month, so mismatched cash flows could be a meaningful hindrance)
So, if the debt ceiling isn’t raised, we don’t have to default on our debt, though we will not be able to fulfill all of the federal governments contractual obligations. We’ll be short $100 billion per month. That is real money. $100 billion less into the economy will cause economic drag for sure. It will result in real job loss. However, it need not be Armageddon. For those directly affected, the adjustment will be unwelcome, difficult, and uncertain. A horrible situation for sure. Without government, most Americans who rely on it will have to turn to themselves, their family, their fiends, and/or the private sector.
It is useful for Republicans and conservatives to remember, they don’t control the federal government. As great as the 2010 elections were for the Right, they only control the House of Representatives. The Senate and the Executive branch are in Democrat control. Such is the messy nature of our beautifully conceived divided government. The argument by the Right to not raise the debt ceiling nor taxes is compelling and appropriate. However, it is an argument that doesn’t work for the Senate or the President. Our elected officials must admit they failed to come up with a workable plan on time.
There is still yet another risk. If the Republicans in the House hold firm and don’t allow for an increase in the debt ceiling, we may have a Constitutional crisis on our hands which will further add fuel to the financial and economic reactions. Reading between the lines, it sounds like President Obama intends to use some executive power he feels he has to raise the debt ceiling on his own (think 14th Amendment: “The validity of the public debt of the United States…shall not be questioned“).