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Raise the Debt Ceiling

by Ashesh Rambachan

Credit to www.blogging4jobs.com
Credit to www.blogging4jobs.com

Garbage in D.C? Still on the sidewalks. National parks? Closed. The National Zoo’s Panda Cam? Turned off.  On October 1st, Americans across the country awoke to find out that the federal government had shutdown because Congress had not passed a budget for the upcoming fiscal year, the first time this has happened since 1996. The shutdown has forced the government to cease all activities deemed “non-essential,” meaning important functions, like food safety inspections, IRS audits, health research and more, have been put on hold.

Markets are reacting. On September 30, as investors braced themselves for the impending shutdown, the Dow Jones Industrial Average tumbled by over 170 points. Since then, the Dow has fallen by an additional 60 points. More importantly, over 800,000 federal workers have been placed on temporary leave without pay. Economists from Goldman Sachs have estimated that for every day of the shutdown, nearly $400 million is removed from the economy. IHS Global Insight, a market research firm, estimates that every week, the shutdown reduces output by $1.6 billion. The ongoing government shutdown is an economic tragedy. To make matters worse, it is completely self-inflicted, occurring because Republicans have resorted to hostage-taking tactics to peal back the Affordable Care Act.

Luckily, these economic harms will likely be temporary.  The 2 million federal employees working through the shutdown are guaranteed to be paid after the dust has settled. And after past shutdowns, Congress approved measures to retroactively pay those workers placed on temporary leave (although, given the inability of Republican leaders to control their caucus, there is no guarantee that this will happen again).

Sadly, even if Congress is able to pass a budget, on October 17th, it will face an even more important challenge- raising the debt ceiling. The debt ceiling is a cap placed on the total amount of debt the Treasury can issue. It was created by Congress in 1917 to oversee financing for World War I. In August 2011, House Republicans argued against raising the debt ceiling because they didn’t want to encourage future spending. The big problem? That the debt ceiling has nothing to do with future spending. In fact, the debt ceiling prevents the Treasury from paying for current spending obligations i.e. things that Congress already approved.

House Republicans have stopped talking about fiscal responsibility, but they remain unwilling to raise the debt ceiling. In fact, now they are using it as a bargaining chip to get the Affordable Care Act repealed or significantly delayed. But let’s be honest: regardless of how one feels about Obamacare, the idea of using the debt ceiling as a coercive tool is absolutely ludicrous.

Because if the House Republicans were to actually follow through on their threat, and the United States hit the debt ceiling on October 17th, the Treasury would no longer be able to issue bonds and debt to make payments on current spending obligations. The federal government could then only spend what it earns in taxes, meaning that $600 billion would instantaneously be cut from federal spending. That’s the economic equivalent of this government shut down lasting 600 weeks, or nearly 12 years!

Cutting $600 billion dollars from the federal budget is a monumental task, as it would require making unimaginably difficult decisions. Do we pay for Social Security benefits…or veterans’ pensions? Do we gouge education spending or military spending? Faced with all these cuts, investors would start to worry—no, they would start to panic—in fear that the U.S. government wouldn’t making interest payments on its debt. Investors would no longer believe in the “full faith and credit” of the United States of America.

As American Treasury bonds and the faith of investors in the federal government’s creditworthiness serve as the foundation of the global financial system, we would face a full-blown global financial meltdown. As Alan Blinder, professor of economics here at Princeton and former vice chairman of the Federal Reserve’s Board of Governors, explains:

“Dating back to fundamental decisions made by Alexander Hamilton, the nation’s first secretary of the Treasury, the U.S. government has always paid its debts in full and on time. Investors assume it always will. So Treasuries are considered risk-free securities (41).”

That is, US Treasury bonds are considered to be the only truly risk-free asset in the world and as a result, every single other financial instrument—from the debt of other governments, to corporate securities, to home mortgages,– is priced relative to it.  So if investors start to fear that the US government can’t honor its debt obligations, the very foundations of the global financial systems are threatened. Interests rates on loans and debts of all kinds would skyrocket, bringing the US the global economy to its knees. Scary, right?

Some argue that this is merely fear-mongering. However, just look back at August 2011: the last time Republicans threatened to vote against any increase of the debt ceiling. During late July and early August, the Dow Jones fell 2,000 points—just because investors feared that the US might hit the debt ceiling. Even after Congress voted to raise the debt ceiling, the credit rating agency, Standard and Poor, downgraded the federal government’s debt rating from AAA (outstanding) to AA+(excellent) on August 5th 2011. Three days later, the Dow Jones fell 635 points in a single day, one of its worst performances ever.

So in the face of this potentially self-inflicted catastrophe, it is ridiculous that the Republican Party is still willing to use the debt ceiling as a bargaining chip. On October 1, Thomas Mann, from the Brookings Institution, and Norman Ornstein, from the American Enterprise Institute, visited Princeton and gave a public lecture about their book, It’s Even Worse than It Looks. It seems that their analysis on the state of the Republican Party sadly only grows more and more accurate by the day:

“the Republican Party, has become an insurgent outlier- ideologically extreme; contemptuous of the inherited social and economic policy regime; scornful of compromise; unpersuaded by conventional understanding of facts, evidence and science; and dismissive of the legitimacy of its political opposition (XIV).”

Yay America.

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