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3 reasons not to raise the U.S. debt ceiling (next time)…

If one thing was made clear during the shellacking the Democrats got in the mid-term elections of 2010, it was that the American voters are fed up with the uncontrollable spending spree of Washington and the resulting deficits that come along with it.

Debt Increases

By now, most people know that the U.S. has almost $14 trillion in debt and the newly elected congress will need to raise the debt ceiling in March 2011 in order for the government to remain functioning, albeit in a dysfunctional way some may argue.

Certain politicians, especially newly elected tea-party favorites, have been very vocal about not wanting to raise the debt ceiling.  They feel that a strong fiscal signal needs to be send and that includes not raising the debt ceiling.  So the big question is: should or shouldn’t congress raise the debt ceiling come March 2011?  To answer this, let’s look at the actual debt ceiling and what it does.

What is the debt ceiling?

The United States of America is the only country in the world that actually has a law for having a debt ceiling and requires congress to vote on whether to raise it or not in case they are about to reach the ceiling.  The Second Liberty Bond Act of 1917 established a statutory limit on federal debt.  It gave the government more leeway in the administration of debt.  Prior to this act, congress had to vote on every single debt issuance, whereas the new law would allow the government to use more modern management techniques in governing its finances.

Debt Levels

Critics of this law will argue that it fosters uncontrollable spending.  If for example congress raises the debt ceiling by $1 trillion, it is pretty much a guarantee that the government will spend every penny of that without requiring a single vote on each individual spending item (in conjunction with raising the limit that is), thus avoiding a potential  embarrassing vote for the politicians.  If we didn’t have the law, congress would need two votes every time it enacted another spending bill without having the money for it; the first one to pass the actual spending bill and the second one to raise the debt so that the treasury can go ahead and borrow the money to pay for it.

What is the downside of refusing to raise the debt ceiling?

1)      Government would come to a grinding halt almost immediately. Without the ability to borrow anymore money, the government would be faced with a tough dilemma; who to pay first with the little bit of money left?  Under normal circumstances the government takes in about $2.5 trillion in revenues annually (less during the recession, but more without the recession), but lately it’s been spending over $3 trillion annually.  This means that once the $2.5 trillion is spent it can no longer spend additional funds to pay its obligations.  It would be required by law to only spend what it takes in, which in this case would be funds coming in through payroll taxes, etc., but it would be far short to pay all its obligations thus it will default on certain payments.  This means that non-essential spending becomes the victim, such as national parks, department of education, etc.  Thus resulting in a shut-down of the federal government, with the exception of national security matters, such as military spending, border patrol, air traffic, etc.

2)      Economic ripple effect would be devastating to U.S. and global economies.  The U.S. will be roughly $700 – $900 billion short in its obligations and it will have a devastating impact on the economy.  The money it does have will need to go first to institutions, central banks, investors, etc. that own U.S. debt.  Not doing so would result in a run on the bank, in this case the Treasury, wherein everyone will try to cash in their bonds and/or treasury bills.

Foreign Debt

It would collapse the financial systems around the world as the U.S. simply doesn’t have $14 trillion.  Not even its gold reserves would be enough to cover the enormous debt.  Even if it were able to meet its debt obligations to these investors it would result in higher interests rates immediately.  Debt owners will demand a higher interest rate (and they’ll get it), which in turn will ripple down to regular banks and in turn to the consumers.  Mortgage payments, car payments, small business loans, etc. will all be hit with a tsunami of higher costs, thus having an adverse impact on the growth of the economy as fewer funds will become available for reinvestments and consumer spending.

Why can’t we keep raising the debt ceiling?

1)      Even Obama’s Debt Commission and just about every economist will tell you that without strong sustained economic growth you will eventually run into a financial crisis wherein the U.S. will have trouble raising enough debt to cover its obligations.  At some point in the very near future investors will start demanding higher interest rates as the dollar continues to lose its value compared to other indexes.  Higher interests rates can be devastating to economic growth.

2)      The U.S. is losing its political and economic power in the world.  Part of it is because the rest of the world is catching up (India, Brazil and China to name a few), but part of it is that they own U.S. debt.  The next time the Treasury needs to borrow money the Chinese government can simply refuse to do so, if it doesn’t get its wish in other matters (see my point?).

3)      Debt payments take away funds that can be used for other programs, such as fostering job growth programs or rebuilding the U.S. infrastructure, etc.

Debt Projections

What should be the solution?

The U.S. needs to show the world that it’s serious about tackling its debt burden.  It can do that in three ways:

1)      Raise the debt ceiling for the last time in March 2011 and let the world know it will no longer raise the ceiling hereafter

2)      It will cut unnecessary spending and make some austerity cuts in other programs such as defense and Medicare/Medicaid

3)      It will raise revenues in the form of tax increases

It will take a Bi-Partisan effort…

Tea-party Republicans only want tax cuts and they don’t want to raise the debt ceiling.  Democrats and the White House want to increase the taxes on the rich and freeze spending at current levels and raise the debt ceiling.  Republican leadership wants spending cuts, freeze spending at 2008 levels and increases the debt ceiling.  Looking at the different groups there is plenty of room for compromise.

Raise the debt ceiling, but only for the last time.  Cut wasteful spending, across the board, but also raise revenues by increasing taxes in certain areas.  If all these measures are put into place then everyone will get something they can go back to their constituency with and claim a victory.  More important, it will put America back on the road to fiscal responsibility and it will demonstrate to the world that it is serious about its debt obligations.  It will stabilize the dollar and keep interests rates in check and will ensure long term prosperity, both economically and politically for the U.S.

If there was ever a time for politicians to step up to the plate and deliver a sound economic recovery package then that time is now.

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