It Is Far Past Time to Extend Debt Ceiling

July 25, 2011

Time sensitive; for immediate release (838 words)

The Congress is playing a dangerous political game with the lives of all Americans. Many in Congress will protest that that this is no game and that our children’s future is at stake. But the costs will ramp up well before the burden falls upon our children.  Indeed, the damage has already begun and at this point the issue is damage control, not damage avoidance. Moreover, the costs will be far larger if the debt ceiling is not raised than if its opponents stick to their guns.

Some new congressmen and citizens believe that there is plenty of money to pay our bills, without extending the ceiling, and that even if there is not, the U.S. Treasury can just channel funds to debt service and avoid default. How ironic that these same observers were just weeks ago bemoaning the fact the government is borrowing 40 cents of every dollar that they have committed to spend. Could any family borrowing 40 cents of every dollar it spends continue to meets its spending commitments by declaring that it will not pay its bills?

This is a rare new form of national “exceptionalism.” Many foreign governments have histories of not paying their bills, or simply not getting their fiscal houses in order, so that investors doubt their ability or willingness to pay their creditors. In the event, credit was downgraded, interest rates rose, foreigners were not willing to buy government debt or private assets, their currency value plummeted, and output, employment and growth declined.   

Flirting with not paying debts is not a short-term technical issue either. These effects persist long after the actions signaling a reduced ability or willingness to pay are taken.

The most fundamental rule used by credit raters and investors is that the risk of default is greatest among borrowers who have experienced default or have skirted close to default. It is the crude principle that “if one has tasted blood, they will kill again.” The principle works for debtors, probably better than for murderers. And that principle will shortly be applied to the U.S. Congress and the nation’s taxpayers, whether or not it is fair and accurate.  

The adverse effects of the current debate cannot be postponed, even for a few months. Treasury Secretary Geithner has declared that August 2 is a magic date where the money runs out. But he has also explained that the U.S. passed the point of being able to pay its bills without borrowing last May. These are payment defaults too; but our credit worthiness is only loosely tied to those obligations, at least in the short run. However, the fact that the country is not paying its bills in a timely manner is not lost on global lenders.

The hardest part of the budget outlay problem without a debt ceiling extension will be that the debt cannot be paid when it is due. It is not just the interest payment, which can be serviced out of existing funds, it is the massive principal payments that have to be paid as debts mature before the outstanding debt can be rolled over.  

Opponents of the debt ceiling claim that this is about our children. They are right, but for a different reason. If parents raise their children that, in a fit of pique about the size of their debt, they can just say they will not pay, then the children will be doomed to live with a substantial decline in their standard of living. Most of Latin America is still paying for such decisions made almost 30 years ago, and in some cases repeated even in the last decade.

Even in the best case of a timely extension of the debt ceiling, global investors will not soon forget the new budget and debt dynamics in the U.S. The issue will continue to arise until the unsustainable spending rise of 5 percent of GDP in the past two and one-half years is reversed and the coming surge in entitlement spending is solved.  Whenever key debt or budget decisions arise, investors now will suffer new doubts about our willingness to pay. And that will be true even if we never actually default. This is the record abroad and it will be no different here.

Just ask the Greeks and many other taxpayers around the periphery of Europe. They thought they had solved their problem a year ago, only to see the huge costs re-arise this year. And this problem will only get worse and continue to re-occur until the Greeks at least, and perhaps others, face the fact that they are not willing or able to pay their debts and no one else is going to pay them either. Default is inevitable there, and the lowest cost for the taxpayers and their children is to face it, take the hit and move on. Is this relevant? Yes, the rapidly moving toward the same situation. The threatened refusal to extend the debt ceiling is just a major landmark on the road to the same end. 

John A. Tatom, Ph.D., is director of research at Networks Financial Institute at Indiana State University and was formerly head of country risk and limit control at UBS AG in Zurich.


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