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By supposedly compromising to raise the debt ceiling, Congress and the
President have now paved the way for ever higher levels of federal spending.
Although, the nation was spared the trauma of borrowing restrictions, the
actual risk of default existed solely in the minds of Washington politicians.
But the real crisis is not, nor has it ever been, the debt ceiling. The
crisis is the debt itself. Economic Armageddon would not have resulted from failure
to raise the ceiling, but it will come because we succeeded in raising it.
This outcome falls along the lines that I had forecast (See my commentary,
"Don't Be Fooled by Political Posturing" from July 9th).
Both parties are now pretending that the promised cuts in spending
outweigh the increase in the debt limit. But the $900 billion in identified
cuts are spread over a decade and are skewed toward the end of that period.
There are an additional $1.4 trillion in cuts that the plan assumes will be
identified by a bi-partisan budget committee. But similarly empowered panels
in the past have almost never delivered on their mandates.
More importantly, none of these "cuts" are actually binding.
There is plenty of time for future Congresses to reverse what was so
laboriously agreed to over the past few weeks. My guess is renewed economic
weakness will be used to justify ultimate suspension of the cuts. In
addition, most of the spending reductions were already scheduled to take
effect before this agreement. So what did we really get?
The Congressional Budget Office currently projects that $9.5 trillion
in new debt will have to be issued over the next 10 years. Even if all of the
reductions proposed in the deal were to come to pass, which is highly
unlikely, that would still leave $7.1 trillion in new debt
accumulation by 2021. Our problems have not been solved by a long shot.
Essentially, the structure announced today allows both political parties
to talk about reform without actually changing anything. To underscore that
point, the deal involves less than $25 billion in immediate cuts! This is
less than a rounding error in a $3.8 trillion dollar budget. This is politics
as usual.
Even these estimates are based on rosy economic assumptions that have
no chance coming to fruition. For example, for the current fiscal year,
Washington estimates GDP growth at 4%. But actual growth for the first half
of 2011 is below 1%! If our government is over-estimating our current year's
growth by a factor of 4, how accurate could their forecasts be ten years into
the future? A more honest assessment of likely economic performance would
reveal future budget deficits spiraling out of control.
Some might say that the primary goal of this deal was to avoid the
dreaded credit rating downgrade. Unfortunately, the deal addresses none of
the ratings agencies' stated grievances. If they fail to follow through on
their downgrade warnings, the rating agencies will lose whatever credibility
they have left. For political reasons, the downgrades may not come right
away, but they are inevitable. But as has happened so often in the past, by
the time the tardy downgrades arrive, the market will have likely already
rendered its verdict.
The debt ceiling itself merely represents a self-imposed limit on US
borrowing. Since Congress can vote to raise the limit, its existence has been
more of a political nuisance than an actual barrier. The operative factor is
not how much we allow ourselves to borrow, but how much our creditors are
willing to lend. That type of ceiling can't be raised by an Act of Congress.
Once our creditors come to the conclusion that they have lent beyond our
capacity to repay, they will be very reluctant to lend more. As trillions in
short-term Treasuries mature, the dwindling pool of buyers will demand higher
rates of return to compensate them for the risk. But our government is in no
condition to afford those higher rates without gutting the rest of the budget.
Last week, it was revealed that despite Obama's warnings that a
default would immediately occur if the debt ceiling were not raised, the
administration had already agreed to prioritize interest payments to avoid
default. Such preferential treatment is only possible because current
interest rates are so low and debt service represents only about 10% of total
revenue. When the pool of willing lenders evaporates, net interest payments
could quickly consume more than 50% of federal revenue. This is particularly
true since rising rates will also plunge the economy into a recession that
will substantially reduce revenues - even as debt payments surge.
At that point, prioritizing interest payments would mean deep
sacrifices in the rest of the federal budget - including Social Security,
Medicare, and the Armed Forces. The question then becomes: will US
politicians really be willing to take the political heat that would emerge
from prioritizing interest payments to foreign creditors over payments to
American voters?
I expect that as soon as our creditors decide that they are no longer
willing to lend to us at ultra-low rates of interest, we will refuse to repay
what they have already lent.
Besides default or major cuts to domestic spending, inflation provides
the only other means for the government to deal with this intractable crisis.
Because of its political palatability, inflation is, in fact, the most likely
outcome. Once we go down that path, we risk high inflation turning into
hyperinflation, which would decimate the remainder of our economy. So, as our
leaders congratulate themselves for saving the nation, the reality is that
they may have just sold it down the river.
Peter Schiff
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