Commentary: Playing Chicken with the Debt Ceiling

Though it may be difficult to believe, Congress's budget trials and tribulations continue. While members of both parties are sorting through the details of April's fiscal year (FY) 2011 spending deal and sparring over the FY 2012 budget, the deadline to raise the nation's debt ceiling is fast approaching. Though the consequences of failing to increase the debt ceiling would be serious, some members of Congress have decided that they would rather play a game of "chicken" than address the issue in a responsible way.

In early August, the Department of the Treasury says, the federal government will hit the so-called "debt ceiling." Rather than quickly approve what should be a no-brainer, giving the Treasury authority to continue borrowing to finance spending decisions already agreed to by previous Congresses, some in Congress are letting the clock wind down as they argue over what conditions should accompany such a vote.

If Congress does not vote to raise the ceiling, the government will no longer be able to borrow money. And with the government borrowing 40 cents of every dollar it spends, the ability to borrow is essential to keeping the government operating.

Even more critical, however, is that without this borrowing ability, the federal government will default on its debt, throwing the world financial markets into turmoil. It would cause "catastrophic damage to the economy, potentially much more harmful than the effects of the financial crisis of 2008 and 2009," Treasury Secretary Timothy Geithner has warned.

Most Republicans and Democrats recognize that increasing the debt ceiling is one of a few "must-pass" pieces of legislation and are now making demands in return for their votes. What was once considered a simple part of making government work has turned into a politically loaded showdown with huge economic consequences.

Geithner has repeatedly called for a clean bill to increase the debt ceiling, but President Obama himself acknowledged that he will probably have to give in to some Republican demands. Compounding the failure of leadership, Senate Majority Leader Harry Reid (D-NV) first echoed the call for a clean bill but then softened his stance and endorsed deficit caps as a budget reform proposal "to prove that we're willing to do something about the debt."

In addition, some so-called budget hawks are demanding that a debt ceiling vote be tied to deficit reduction, while others are calling for significant budget cuts, spending caps, or a balanced budget amendment.

It seems strange to need a vote to raise the debt ceiling in the first place, much less a piece of legislation larded with other policy measures. After all, Congress has already decided to spend the money in question. Former Federal Reserve Chairman Alan Greenspan pondered this situation in an April appearance on Meet the Press:

Why do we have a debt limit in the first place? We appropriate funds, we have tax law, and one reasonably adept at arithmetic can calculate what the debt change is going to be.... The Congress and the president have signed legislation predetermining what that number is. Why we need suspenders and belts is something I've never understood.

Indeed, in April, the House overwhelmingly approved a FY 2012 budget resolution that would add billions of dollars to the federal debt. Raising the debt ceiling is an unavoidable consequence of allowing the federal government to borrow money, money that Congress has already agreed to spend beyond the revenues it has agreed to collect. Failure to raise the debt ceiling would be Congress's "most asinine act," according to mega-investor Warren Buffett.

The consequences for not increasing the debt ceiling are grave. Right now, U.S. debt is considered the safest investment anyone can make; it is deemed to be risk-free. This is because investors trust the federal government to always pay off its debts. It's a reasonable trust because America has not defaulted on its debts in recent history and currently has more than sufficient means to continue to pay it off. However, if Congress refuses to raise the debt ceiling and the government cannot borrow to continue staying current on the debts already incurred, investors will likely find another country (like Germany) in which to relocate their money. This will greatly devalue U.S. debt, sending large ripples throughout the world economy. In a letter to its clients, economic analysis firm IHS Global Insight noted that "[f]ailing to service or redeem debt would lead to damage cascading though financial markets, as debt-holders would be unable to meet their own obligations..."

Additionally, the domestic economy, which is built on a bedrock of U.S. debt with low interest, could be thrown into chaos, as everything from home mortgage interest rates to credit card rates adjust to take into account the fact that U.S. debt is no longer the gold standard of risk-free lending. Federal Reserve Chairman Ben Bernanke testified before the Senate that default "would be extremely dangerous and [a] likely recovery-ending event." In the letter cited above, IHS analysts commented that "[i]t is hard to think of a bigger self-inflicted wound for a $10 trillion debtor than failing to service that debt."

In other words, not raising the debt ceiling should not be a policy option – not even as a threat.

Congress's dithering is already impacting the nation. In order to give the legislative branch more time before the debt ceiling is reached, Treasury has ceased selling special bonds to state and local governments that help them finance their operations. As Geithner detailed in a letter to Congress, the move "is not without costs; it will deprive state and local governments of an important tool to manage their outstanding debt expenses." The costs will only grow as we get closer to early August.

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