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Debt Ceiling: What's the Worst That Can Happen?   May 31st, 2011
It's really not all that bad       

 
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The rhetoric related to increasing the debt ceiling continues, but what's the worst that could really happen? I'll tell you what: We'd get our spending under control and set the stage for a real recovery.

Treasury Secretary Geithner recently stated:

Now is the time to figure out how to rein in deficits, but even if lawmakers can't come to an agreement by early August, they will need to raise the debt ceiling, Treasury Secretary Tim Geithner said Tuesday evening.

"It simply is not an option for Congress to evade the basic responsibility to protect America's creditworthiness," Geithner said at the Harvard Club in New York City...

During the Harvard Club event he allowed that no one can say for sure what would happen specifically come Aug. 2 if lawmakers don't raise the $14.3 trillion debt ceiling isn't raised.

Treasury Secretary Timothy Geithner says that if Republicans insist on passage of their budget plan as a condition for approving an increase in the nation's borrowing limit, they will be responsible for the consequences.


As I've already written, I'm of the opinion that the potential consequences are being severely overblown. Unless President Obama and Secretary Geithner are intent on destroying the economy, the worst that will happen is that there will be a widescale government shutdown, or only partial government payments will be made to all recipients of government money (except for bondholders which would logically be paid in full to maintain our credit rating).

And while Republicans would certainly receive the credit for stopping the government from adding further to its debt, it would be either Obama or Geithner that would be responsible for consequences if bondholders are not paid. Congress can refuse to increase the debt ceiling, but it is Obama or Geithner who will decide how to pay our bills should the debt ceiling not increase. They can either prioritize payments to bondholders or they can crash the bond market, spike interest rates, and stall the recovery if they refuse to do so. That decision is up to them.

Shutdown and Recovery

In any case... if I'm wrong about the consequences of refusing to raise the debt ceiling, or if Obama and Geithner decide to crash the economy by refusing to prioritize payment to bondholders, what's the worst that can happen?

The worst that can happen is that interest rates will rise enough that the government will no longer be able to afford to engage in deficit spending. The Federal Reserve will be unable to print enough dollars. The government and the Federal Reserve together will no longer be able to hide the still-dismal state of the economy.

Our economy is on the edge. The "correction" of 2008 is not yet complete. There will be more pain. But the government and the Federal Reserve have continued policies that are delaying the inevitable completion of the correction by borrowing and printing money at astronomical levels. The correction is inevitable and will come eventually. The longer the government tries to avoid reality, the more painful it will eventually be and the longer we'll suffer high unemployment.

So if failing to raise the debt ceiling actually causes all the "nightmare" scenarios that Geithner is predicting, the worst that can really happen is that we'll finally have the economic correction that's going to come sooner or later. The government will no longer be able to prevent it. It will be painful, but we need to work through the rest of this recession before we can recover. The longer we wait, the longer we'll be in pain--and the more painful the final correction will be.

Aside from getting through the recession so we can finally start a real recovery, the other outcome of such a "nightmare" scenario is that fiscal conservatism will follow. Whether Republicans or Democrats are in power, we will have fiscal conservatism because we will not be able to afford any other course of action.

Political Risk

The very real political risk is that Republicans will be blamed for all economic problems that come thereafter, regardless of whether or not it's accurate to cast the blame.

There really isn't much doubt anymore that our economy is going to experience a double-dip. Even if all government spending and money-printing is continued, our economy is struggling. We've only avoided (and prolonged) the pain because of artificial government spending and money-printing. When that inevitably ends, we will experience the rest of the recession that we've been avoiding.

So after Republicans refuse to raise the debt ceiling...
  • Democrats will blame Republicans for a double-dip recession -- even though our economy is already slowing down.
  • Democrats will blame Republicans when home prices go down further -- even though home prices are already in double-dip territory.
  • Democrats will blame Republicans when interest rates go up -- even though they're only low now because they're being manipulated by the Federal Reserve
  • Democrats will blame Republicans when unemployment goes up -- even though employment in the U.S. is already lackluster.
  • Democrats will blame Republicans if the dollar collapses -- even though the UN is already warning of that possibility due to artificially low interest rates and unsustainable debt.

So the political reality is that Republicans better do a really good job explaining economics to the country... because the sound-bites that will be hurled back at Republicans will sting.

In my opinion, the message has to be: America is addicted to deficit spending just like a drug user is addicted to cocaine. Like cocaine, deficit spending will destroy us if we continue. Before we can recover, we have to kick the addiction. And there will be painful withdrawal symptoms. But we know it's for the best and, in the end, we'll be healthier and stronger.

It Needs To Be Done

Although the politics are difficult--especially entering a presidential election cycle--this has to be about saving our country. Our annual deficit is the single largest threat to our country right now.

If the goal is fiscal conservatism, the debt ceiling is our ultimate leverage. We can't force Rep. Ryan Paul's budget through the Democrat Senate or through an Obama White House. But we don't have to. All we have to do is refuse to raise the debt ceiling. Republicans are holding all the cards right now. So if Republicans are going to raise the debt ceiling, they better get some real serious concessions in return.

I wrote back in January that we may very well know the fate of our economy and our country by late spring.

It's now late spring and I think we'll know the answer soon.

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