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Today the U.S. government officially borrowed beyond its $14.29 trillion
statutory debt limit. And even though the Obama administration has assured us
that accounting gimmickry will allow the government to borrow for another few
months, the breach has given seeming urgency to Congressional negotiations to
raise the debt ceiling.
Republicans are making a great show of acting tough by linking their
"yes" votes with promises for future budget cuts (that could even
slow the rate of debt increases at some uncertain point in the future). But
as we go through the process, many novice observers may wonder why we have a
debt ceiling at all when our government has never shown the slightest
inclination to respect its prior self-imposed limits.
The ceiling was first imposed in 1917 as part of a deal that passed the
Liberty Bond Act that funded America's entry into the First World War. To
make it easy for the Treasury to sell those bonds, Congress also amended the
Federal Reserve Act to allow the Fed to hold government bonds as collateral.
But given the potential for unchecked Federal deficits, Congress sought to
limit taxpayer exposure to $11.5 billion.
The problem was that Congress never passed a law to prevent future
Congresses from raising the ceiling. And even if it had, that law could have
been rewritten by future legislation. Sure enough, when the Second World War
rolled around the debt limit was raised frantically, leaving it at $300
billion by 1945. But believe it or not, after the War ended, the limit was
actually reduced to $275 billion.
Despite the costs associated with the Korean War, the next increase did
not come until 1954. And over the ensuing eight years, the ceiling was raised
seven times and reduced twice, finally getting back to $300 billion in 1962.
Since then, Congress has voted to raise the ceiling 74 times without a single
reduction.
Practically speaking, a ceiling that is raised automatically is no
ceiling at all.
Given that, why not dispense with the pretense? The reason is politics.
No Congressman wants to be on the record voting for unlimited debt, yet most
are willing to rail against fiscal recklessness while raising the ceiling
every time it's reached. Any Congressman who gives lip service to a balanced
budget Amendment but votes to raise the debt ceiling is a hypocrite. No one
needs constitutional help to hold the line on the debt right now!
But epic levels of Federal red ink and the approach of the 2012 elections
have raised the stakes. Despite the newfound urgency, nearly all Democrats
and a very large chunk of Republicans argue that failure to raise the ceiling
will be tantamount to economic suicide. They argue that such a rash move will
cause the U.S. to default on outstanding debt obligations, thereby sending
interest rates sharply higher across the board. Higher interest rates they
argue would cripple the economy and permanently increase debt service costs.
As a result, they predict capping debt now will precipitate a far deeper
economic contraction than what we have already seen in the last few years.
Few see the inherent absurdity in the notion that taking on more debt
improves the economic health and creditworthiness of the United States. I
would argue for the much simpler idea that more debt weakens a nation's
financial position. More importantly, capping U.S. debt at current levels
means bringing a future crisis into the present where it can be dealt with in
practical terms. This is something that nobody in Washington actually wants.
If we do today what we have failed to do in the past, we very may well
default on a portion of our debt. No doubt our creditors will suffer. But
such near term pain will lead to a quicker and healthier recovery. Out of
control Federal spending will have to be dealt with now. A downgraded credit
rating will make it harder for the United States to continue borrowing, and
as a result should be viewed as a blessing in disguise.
A reduction in debt levels is good economics. Remember, taxpayers will
have to repay with interest anything the government borrows now. The more the
government borrows, the larger it grows, and the larger it grows, the weaker
the economy becomes. The less money the government borrows, the more that is
available for the private sector to borrow to increase production and create
jobs.
Failing to raise the debt ceiling will force Congress and the President
to tell the truth to Social Security and Medicare beneficiaries who have been
promised more than taxpayers can deliver. They will have to concede that
so-called government "trust funds" are mere accounting gimmicks,
and that benefits will need to be cut if the
programs are to be solvent. They will have to tell the truth to our creditors
that the U.S government has borrowed beyond the ability of its citizens to
repay.
And lastly, the stark reality will force the government to tell the truth
to Federal employees whose salaries and benefits are unsupportable given our
fiscal weakness.
But, on the other hand, if we raise the debt ceiling, we can postpone the
crisis into an indefinite future. All of these tough choices could be
avoided. Government pay and benefits will flow unabated, and our creditors
will continue to get their interest payments now. But in the future, the
value of principal repayments and government benefits and paychecks will lose
purchasing power. That's because if we keep raising the ceiling indefinitely,
we risk destroying our currency. But the long slow death of a currency and the
ebbing of a nation's economic vitality doesn't make
for huge headlines.
It is for that reason I am 100% confident that Congress will do the wrong
thing and raise the debt ceiling for the 75th time in 50 years. In the end
there will be some kind of phony compromise with each side claiming victory.
But while the politicians celebrate another dodged bullet, the U.S. economy
will continue to be shot full of holes.
Peter Schiff
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Peter
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