Points About The Debt Ceiling

Posted by Jeff Carter
on July 16th, 2011

Politicians are out there spreading falsehoods about this whole debt ceiling debate. Many of them are economically challenged anyway, so it’s not surprising. They just want to scare you so they can move public opinion for their own negotiating leverage.

Thankfully, it’s not working for either side which forces them to actually do something. The public is tuning Washington out.

First of all, what is the debt ceiling? It is the amount that the US is legally allowed to borrow. The debt ceiling today is 14.3 trillion dollars. Years ago, it was much smaller.

Having a large debt ceiling isn’t necessarily a bad thing. Why? Because larger economies can support more debt. To grow your GDP you face two choices-grow with cash, or grow with leverage(debt). Leverage magnifies returns. But as we know leverage is a double edged sword.

At this point, it’s also important to note that it’s critically important to know what the government is spending their money on. As we know all too well, government spends its money on inefficient projects that do nothing to grow an economy. That’s why people are ticked off about the debt ceiling; basic government inefficiency.

In 1975 Senator William Proxmire started the Golden Fleece Award. While it was funny, it didn’t have any effect on government spending. The time for satire is over.

Will Social Security and Medicaid payments be hindered if we don’t raise the debt ceiling? Short answer, No. Long answer, it depends. Social Security and Medicare/Medicaid are solvent today. Based on net present value analysis, and based on the averages going forward, they won’t be solvent down the road unless we change the way we administer these programs. That’s why Paul Ryan came up with his plan.

Who feels the heat when the debt ceiling is reached? Tim Geithner, Secretary of the Treasury. Since Treasury authorizes payments of all bills, he gets to try to find ways to make those payments without going over the ceiling. Legally, he is stuck on certain things. Once those get paid he moves on. There are some things that can be stopped immediately-like simply not funding certain projects. He also can delay making payments to federal retirement accounts. He can negotiate with creditors to stretch out payments.

This also means that he can get political with which projects he chooses to fund, which he chooses to kill, and which he chooses to put on financial life support. More government picking of winners and losers.

The military will still get paid. But, certain government employees won’t get checks. Monuments, national parks and museums will be closed. A federal agency like the National Institute of Health will have to stop clinical trials. Maybe Congress ought to forgo pay, and have their staffers forgo pay until a compromise is found. Not to worried about the Congressman but their staffers really run the show there. Tick them off and Congressman will be jumpin’!

What if the US were to default? According to some academics I know, it is actually okay to default. But, and it’s a big but, a country can only default one time. The problem is, government can never control it’s spending so it always happens more than once. Think Argentina. John Cochrane actually said this at a symposium I was at. Charlie Evans, Chicago Fed President said, “What do you want us to do default?”. Cochrane quickly responded, “Yes, one time. Then never do it again.”.

In the case of default, the world would not end-but the US would be forced to change a lot. The interest rates everyone pays, even for private funding would be significantly higher. Credit would be a lot tighter. The value of the dollar would plummet and we would have a lot of inflation. None of these are really great alternatives, and truly I don’t think either side really wants a default.

But each side has drawn lines in the sand. Repeal Obamacare and the debt ceiling is safe. Raise taxes significantly, and it’s also safe. Each for a very short period of time because government spends so much, and does so much, that we will be having this debate again soon.

How should they compromise? The compromise should be to raise the debt ceiling, cut a large amount of discretionary spending and planned future spending, keep tax rates the same, and then move on.

Let’s settle it in 2012 when we have an election.

Welcome readers of ycombinator

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.