Politics and the debt ceiling

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I’ll admit to not being an economist; but as the son of a banker, I have almost an innate appreciation for the importance of meeting obligations. The recent discussion in Washington about raising the debt ceiling has brought about serious concerns from the financial community about the consequences of not doing so.

On Wednesday, the first day of the new Republican House majority, the House voted to require a separate vote on raising this ceiling. The singling-out of this issue suggests an imminent political showdown. Bruce Bartlett, a domestic policy advisor during the Reagan administration and a Treasury official under President George H.W. Bush, has called the suggestion of not raising the debt ceiling “the most monumental insanity.”  For starters, there has never been an instance where the debt ceiling hasn’t been raised — so we really don’t know all the potential difficulties we’ll encounter if that happens. But let’s look for a moment at what we do know.

The Russian default in 1998 nearly destroyed at least one large investment bank — Goldman Sachs — and severely tested the World Bank, the International Monetary Fund, and our Federal Reserve System. Long Term Capital Management, an American hedge fund that heavily invested pension funds and other supposedly risk-averse capital in Russian obligations, lost $4.6 billion in four short months — much of it coming from Goldman Sachs. Russia’s inflation rate skyrocketed to 85%, its currency, the ruble, was devalued to the point where leading capitalists said it should be abandoned, and interest rates went up dramatically, reflecting the risk those investing in Russian obligations were assuming.

The European Sovereign Debt Crisis, which started in early 2010, manifested through a combination of corruption and overspending, brought the economy of Greece to the breaking point, or “default line,” if you will. Default was prevented only through intervention by the European Monetary Fund. Even so, its debt was downgraded by Standard and Poor’s and other ratings agencies to “junk” status. This caused government bond yields to approach 15%, which dramatically reduced the attractiveness of government bonds to investors, whose capital is required to keep the wheels of government rolling. Greece, Ireland, Spain, Portugal, Italy and other potentially unstable nations involved in the European Sovereign Debt Crisis would face even more disastrous economic consequences if they were to actually default.

In today’s America, we have been fortunate in that our Treasury bonds, the instruments that fund our government operations — and overspending — have still enjoyed robust demand at auction. The yields are low, inflation here is nearly non-existent, and our political system, relative to most of the rest of the world, is remarkably stable. However, if we choose, for political reasons, not to increase the debt ceiling, we run the risk of damaging what has kept us at the forefront of the world economy: the “Full Faith and Credit of the United States.” If we place even a scintilla of doubt about the stability of our economy into the minds of the countries that fund our debt, such as China, Indonesia and Saudi Arabia, we run the risk of losing the capital we need to pay our various government obligations — including interest on the national debt. Chinese leaders have already publicly expressed concern about our current debt situation. Could they sit on their hands at Treasury auctions? We should hope not.

Moreover, if our credit rating is damaged, the interest rates on our debt obligations will go up, and with less capital to pay down our obligations, we will run a very real risk of defaulting. Could this happen? We don’t know for sure because, again, not raising the debt ceiling is unprecedented.

In a recent interview with Salon, Bartlett likened the current political rancor over the debt ceiling to an economic version of the James Dean film Rebel Without a Cause: “I think that we may in fact reach a point … where a day comes and the Treasury has to pay out X billion in dollars to Treasury bond and bill and note holders, and it has less than X dollars literally in its account to pay that interest. I’m hypothesizing that as a possibility because I really think that this is a game of chicken and I think that the Tea Party people are willing to go over the cliff to prove their point, to prove that they are not chicken.”

In the final analysis, it may be a game of chicken, but Congress should understand it has to do what’s right in the near-term and then work together to remedy the causes. Raise the debt ceiling, go to a “Paygo” (pay as you go) system in funding federal obligations, and responsibly cut expenditures — across the board — which, though painful, will help restore our budgetary health. We can no longer afford to introduce new government initiatives that are unpaid for. This will only ensure that we’ll wind up in this same situation again, somewhere — and soon — down the road.

Christopher Hartman is the author of “Advance Man: The Life and Times of Harry Hoagland”; editor of “Learn Earn and Return: My Life as a Computer Pioneer,” a memoir of Harlan Anderson, co-founder of Digital Equipment Corporation, and contributor to the Christian Science Monitor newspaper.