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Friday, July 8, 2011

About that Debt Limit

Maxing out the credit card panics the politicians.

What’s the point of a debt ceiling if raising it is a mere formality?

As the U.S. government neared its $14.29 trillion debt limit, the congressional vote to raise it was expected to be uncontroversial. That’s pretty much how it’s been in the past. In the first decade of this century, the limit was raised a half-dozen times. But this time it’s different. The public is worried about the inconceivably large budget deficits and a total national debt that approaches 100 percent of GDP. Politicians, opportunistically and otherwise, decided to cash in — pun intended – on the public’s concern: There would be no raising the debt limit without a deficit-reduction plan.

At first this position was treated as outrageous. Grownups, the “serious” pundits said, don’t act like this. Grownups would simply raise the limit – enabling the government to incur new debt in order to pay the interest on old debt. It’s an odd idea of what grownups do. But the public was in a deficit-reducing mood, so the demand for a “clean” debt-ceiling bill softened.

So here we are. The debt limit technically was reached in May, but Treasury Secretary Tim Geithner engaged in some accounting maneuvers to pay the bills, extending the de facto deadline to early August. (Robert Murphy has the details.) That leaves just a few weeks to come up with a deal. Efforts at compromise so far have yielded nothing. The hitch is that President Obama and congressional Democrats want new tax revenues to go along with spending cuts, while Republicans oppose increasing taxes. There’s been some ambiguity in the GOP ranks over whether ending corporate tax credits or deductions counts as a tax increase. We’ll let that go here, except to say that giving politicians more money to spend is the nuttiest thing I can imagine.

Catastrophe in the Offing?

The message from Washington – and from most pundits – is that if the debt ceiling is not raised, great catastrophe will befall the United States of America and its people.

Is it true? Consider the source. The people telling us this are the same people who think government spending and tax revenues are never high enough. These are the people who measure “national greatness” in budgetary terms. Of course they’d panic at the news that their credit cards are maxed out.

Would the sky fall if the government couldn’t borrow another penny? Robert Higgs addresses the question:

Have governments defaulted in the past? Of course, they have, on hundreds of occasions over the centuries. Have these defaults triggered “catastrophic economic and market consequences”? No. When a government defaults, there are consequences, of course, including heightened reluctance of lenders to lend to the deadbeat government in the future or at least to lend at such favorable interest rates. Often partial payments of principal and interest are arranged or debts are restructured. The world keeps spinning.

Yes, but we’re not talking just any nation. We’re talking about the United States — American exceptionalism and all that. Writes Higgs:

Has the U.S. government ever defaulted before? Yes, in 1933, by refusing to honor the gold clauses in its bonds, the Treasury engaged in a massive default. Ironically, for mainstream economists and economic historians, the government’s abandonment of the gold standard, along with its associated default on its gold obligations, is seen as the decisive government action that stopped the Great Contraction and set in motion a recovery from the Depression. (Don’t laugh: for some time, this interpretation has been the reigning view in academia.)

Religious Tones

Peter Klein, another excellent economist, notices what I’ve noticed. Pundits and politicians talk about the government in almost religious tones. Its word is sacred, and thus default would be an unspeakable sin.

In following the debates over raising the US debt ceiling I’m struck by the frequent claim that defaulting on public debt is unthinkable because of the “signal” that would send. If you can’t rely on the T-Bill, what can you rely on? Debt instruments backed by the “full faith and credit of the United States” are supposed to be risk-free, almost magically so, somehow transcending the vagaries of ordinary debt markets. The Treasury Bill, in other words, has become a myth and symbol, just like the Constitution.

I find this line of reasoning unpersuasive. A T-bill is a bond, just like any other bond. Corporations, municipalities, and other issuers default on bonds all the time, and the results are hardly catastrophic. Financial markets have been restructuring debt for many centuries, and they’ve gotten pretty good at it. From the discussion regarding T-bills you’d think no one had ever heard of default risk premia before. (Interestingly, this seems to be a case of American exceptionalism; people aren’t particularly happy about Greek, Irish, and Portuguese defaults but no one thinks the world will end because of them.) So, isn’t it time to de-mythologize all this? Treasuries are bonds just like any other bonds. There’s nothing magic, mythical, or sacred about them. A default on US government debt is no more or less radical than a default on any other kind of debt.

Chris Matthews would be screaming, “Heretic!” right about now.

But come on. Really. The fate of the world hinges on the U.S. government’s credibility? That’s a joke, right? Have you followed WikiLeaks? Why are financial obligations more sacred than human rights obligations?

$750 Billion

Yet another wise economist, Robert P. Murphy, puts in all in perspective.

Debt service currently consumes about one-sixth of incoming revenues….

[I]f the government merely returned to its 2003 spending levels, then the current revenue stream would be enough to pay for everything — including interest on existing debt. I personally don’t remember the country falling apart in 2003 from lack of federal-government expenditures.

That would mean cutting $750 billion from the nearly $4 trillion budget. (One item, the war in Afghanistan, costs $10 billion a month.) Murphy suggests that if the politicians don’t want to cut spending, they could sell off government assets to get the money. No need to raise the debt ceiling.

Those are moderate solutions that would leave no lasting reforms. Default would bring lasting benefits. For one thing, it would make people less eager to lend to the U.S. government, and how could that be bad? Debt, among other evils, makes government bigger. As Jeffrey Rogers Hummel says, default would be a balanced-budget amendment with teeth!

The government should indeed give up its land and other assets, but I don’t see why its voluntary creditors should be first in line for payment when there are so many coerced creditors around, including Social Security recipients, who had their potential savings stolen throughout their lives.

Consenting creditors – people who chose to buy T-bills – count on getting repaid with stolen property, aka tax revenue, which in my book taints the contract. If justice is the standard, the State’s victims should get restitution first.

  • Sheldon Richman is the former editor of The Freeman and a contributor to The Concise Encyclopedia of Economics. He is the author of Separating School and State: How to Liberate America's Families and thousands of articles.