tbo: Tampa Bay Online.
Monday, May 22, 2017

Five results of refusing to raise the debt ceiling

The global economy is facing a bizarre man-made threat: Radical legislators in the United States, issuer of the world’s most trusted currency, think forcing the government to renege on its obligations would be a good way to shock it into recognizing the error of its fiscally imprudent ways.

Here’s what would happen if that threat were carried out.

To keep spending, the government needs Congress to pass a spending law. Republicans have already blocked this, resulting in a partial government shutdown. Now they are threatening the separate and much more disruptive step of refusing to raise the federal debt ceiling, currently set at $16.7 trillion. If the debt ceiling stays in place, the Treasury will run short of cash soon after Oct. 17. At that point:

1. Global markets will see the U.S. government as grossly and dangerously incompetent. It’s as though Congress were sending the Treasury two contradictory and legally binding orders — one that requires it to make hundreds of billions of dollars a month in payments and another that prevents it from borrowing the money it needs to do so. Confidence matters, and this event would destroy confidence.

2. Forced spending cuts will kill the economic recovery. Over the course of a year, the Treasury borrows roughly $1 out of every $5 it spends, so hitting the debt ceiling would require it to cut outlays by about a fifth — and by much more in the short term, because flows into and out of the Treasury are lumpy. Such a severe fiscal squeeze would crush a still-tentative recovery at a time when widespread unemployment is threatening to do permanent damage to the country’s productive capacity.

3. The U.S. government might actually default on its debts. Some in Congress apparently think that hitting the debt ceiling needn’t mean missing a payment on the $12 trillion in government bonds outstanding — an event that markets would call a default, which could trigger a financial catastrophe (see No. 4). The House of Representatives has passed legislation to authorize the Treasury to prioritize such payments.

4. A default could trigger a global crash. Treasury bonds are the foundation of the U.S. and global financial systems. The slightest concern about the U.S. government’s ability or willingness to pay could prompt investors to demand a higher return on the bonds and dealers to toughen the terms on which they accept Treasuries as collateral. That would abruptly raise the cost of credit for everyone — or else freeze financial markets altogether.

5. The government’s fiscal problems will only get worse.

Heightened fears among investors will increase the government’s cost of borrowing. Even a rise of 1 percentage point would increase the government’s costs by $120 billion a year. The longer-term fiscal problem is readily soluble.

Threatening a sovereign default, with all the enormous risks it entails, is not part of the solution. Arguing otherwise carries irresponsibility into the realm of insanity.

Weather Center

10Weather WTSP