OPINION:
The clock is chiming the 11th hour as the United States approaches default on its sovereign debt - or so we are told. The drama over the supposed Aug. 2 deadline always has been contrived.
The federal government expects to take in about $172 billion in tax revenues in August. To prevent a technical default, the Treasury needs to make interest payments of about $29 billion due Aug. 15. There also is a $90 billion debt in the form of Treasury bills and long-term securities that matures on Aug. 4. In theory, all of these obligations can be met with current tax revenues. These bills can be paid.
The federal government, of course, has promised to pay quite a few more people. The Social Security and Medicare entitlements present the largest claim. Then there’s what is termed discretionary spending, such as defense. Millions of federal employees demand their paychecks. After adding all of these expenses, there isn’t enough money to make the payments without borrowing. Hence the need to raise the debt ceiling.
What happens if the debt deals fall apart at the last minute? In the worst-case scenario, the United States could lose its much-prized AAA rating. Such a downgrade would spook the markets in a big way. The cost of borrowing for both the government and consumers would go up, but that would be neither undeserved nor a disaster. A lowered rating provides an accurate reflection of our current economic reality. We have out-of-control debt, a rapid increase in entitlements without a plan to fund them, and a crippling level of regulatory uncertainty. The ratings agencies have indicated that these long-term fundamentals worry them just as much as the fact that the president and Congress have failed to come to an agreement on the immediate problem of the debt ceiling. A lowered rating and the higher borrowing cost serve as the punch to the gut needed to spur a true resolve to curb Washington’s spending addiction.
Dire predictions about the adverse impact of higher interest rates on the rest of the economy might well be overstated. The Federal Reserve’s quantitative-easing policy has kept the cost of borrowing artificially low. Even near-zero rates have failed to inspire banks to lend or businesses to invest. The private sector is sitting on reserves, afraid of being saddled with new taxes and crippled by new regulations that are the natural byproduct of government gone wild. Higher interest rates won’t change that calculus much.
On the other hand, savers - the people who hold the Treasury bills the government is selling - will see their incomes go up if interest rates rise. This is one channel that was ignored in the calculations over monetary easing, and it is being ignored now. Higher interest rates have a positive income effect.
This modest side benefit wouldn’t be enough to offset the very serious impact of a downgrade of U.S. debt on financial markets, but a far worse crisis is looming. Agreeing out of fear to more borrowing and spending without entitlement reform brings closer the far more serious day when the monthly debt-service bill exceeds our borrowing capacity. That’s when America really hits the wall.
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