print logo
RSS FEED

How to Fix the Debt Ceiling (A Bigger Threat Than the Fiscal Cliff)

Saturday, November 17, 2012

A default by the U.S. government is more potentially damaging than the fiscal cliff — and more easily avoidable, if Congress modernizes the debt ceiling.

The fiscal cliff — sudden and painful tax hikes and spending cuts — is widely recognized as a looming threat to the economy. The worst scenario, a so-called “hard landing,” is reportedly avoidable only if Congress and the president can agree and take action by January 2013.

However, the fiscal cliff is the lesser of two approaching crises; the other crisis is more potentially damaging and, ironically, more easily avoidable: a first-ever default by the U.S. government on its bill-paying obligations, should Congress fail to raise the federal debt limit in the next few months. The figure below shows how close the federal debt has come to the debt limit, as of November 13, 2012.

Both of the approaching crises — the fiscal cliff and the default threat — would be triggered by government’s failure to take action. The fiscal cliff entails near-instantaneous tax hikes and spending cuts that experts say would be too much, too fast, too arbitrary, and too soon. But a first-ever default (resulting from failure by Congress to raise the statutory debt limit) would be worse, because it would force much larger instantaneous spending reductions  — mostly in critical big-ticket categories such as Medicare, Social Security, defense, and — worst of all — interest on the debt, which would be the doomsday scenario of self-inflicted national bankruptcy.

If the fiscal cliff’s “hard landing” scenario would be a disaster, default would be suicide. Failure to raise the debt limit in time to prevent default would not only create fiscal havoc internally, it could trigger an unraveling of the world’s confidence in the U.S. dollar and its Treasury securities. Because the dollar is the world’s preferred reserve currency, the “dollar economy” currently extends far beyond U.S.  borders. If worldwide confidence in the dollar began to erode, foreign countries’ desires to roll their maturing U.S. debt securities into new ones would erode as well, which would only compound the negative consequences for our economy.

Default: An Easily Avoidable Disaster

Again, however, the default disaster is easily avoidable — which begs the question, why not simply continue to increase the self-imposed debt ceiling? After all, it’s just a number thought up by members of Congress, who, for the last century, have been raising it just in time to avoid a first-ever default. The debt ceiling has done little if any good, but retains the potential to do catastrophic harm. Our economic history shows that debt growing in tandem with (or slightly in advance of) economic growth is harmless, even desirable. (Several of my previous articles have covered this in more depth; see “The Buffett Rule,” “What Our Grandkids Actually Want,” and “Why Growth Matters More Than Debt.”) So why would Congress take us to the brink of unnecessary, self-imposed default whenever the debt approaches its arbitrary debt ceiling?

Figure 1: Excerpt from Daily Treasury Statement, November 13, 2012

 final111612

The reason is not grounded in economics, finance, or sound logic. The reason is politics. For at least two decades, the party out of power (i.e., not in control of the White House) has been able, and occasionally willing, to use the debt ceiling as a political weapon. Congressional opponents of the White House have used the debt limit as leverage against President Obama and our two previous presidents, Bush and Clinton. (For example, in 2006, during Bush’s second term, then-Senator Obama voted against raising the ceiling — a decision he regrets in hindsight, now that he is at the White House instead of Capitol Hill.) Current conditions haven’t changed: Obama’s reelection just might embolden Congress’s so-called Tea Party faction to wield the debt-ceiling weapon again, as it did in 2011. Will the outcome be different this time? Is self-inflicted default no longer unthinkable? The prospects are frightening.

Congress Should Modernize the Debt Ceiling

As it is currently defined, the debt ceiling is a nuke in a suicide vest. Congress invented it, Congress is wearing it, and Congress has learned how to use it to threaten opposing-party presidents. The good news is that Congress has the power to disarm it, throw it away, and replace it with something better. It’s time for Congress to do just that.

The current, obsolete debt ceiling is set at a specific dollar level: “X trillion dollars” of debt — similar to setting a mileage limit for a car, which forces a hard stop when the odometer reaches some arbitrary number. A new, better way to limit the debt would be to switch our focus from the odometer to the speedometer, i.e., to set a target ratio for debt relative to the size of our economy — “X percent debt-to-GDP.” A car’s speedometer helps us keep miles-per-hour under control; a new measure for the debt limit would help us keep debt-to-GDP in bounds. It would create new incentives for lawmakers: all of a sudden, a “new” way to stay under the debt limit would be to implement growth-friendly laws and policies that help the economy grow faster than the debt grows.

In short, the dollar-level debt ceiling is obsolete, because it continues to invite politicians to flex their political muscles by threatening default. What we need now is a percent-GDP ceiling — perhaps dubbed the “debt guardrail” — that invites our politicians to foster private sector growth by showing us they can also flex their brain power, instead of just their political muscle.

Steve Conover retired recently from a 35-year career in corporate America. He has a BS in engineering, an MBA in finance, and a PhD in political economy. His website is www.optimist123.com.

FURTHER READING: Conover also writes “It’s Past Time to Stop Blaming Bush,” “The Only Practical Way Out of Our Economic Doldrums,” “Missing in Action: Growth,” and “‘Top-Down’ vs. ‘Bottom-Up.’” Veronique de Rugy says “Another Day Older and Deeper in Debt…” Norman Ornstein discusses “Optimism about the 113th Congress” and “What Would It Take for Action on Fiscal Cliff?

Image by Darren Wamboldt / Bergman Group

Most Viewed Articles

‘The American Banking System Might Not Last Until Monday’ By Alex J. Pollock 08/23/2014
Learning from the crises you’ve forgotten.
The Truth, Probably By Robert McHenry 08/31/2014
We will never attain certainty about our concerns, but with care and luck we approach it by ...
Peanut Butter’s Many Inventors By Edward Tenner 08/15/2014
The popular product illustrates both the opportunities and the risks of intellectual property.
The Long-Hours Luxury By Tino Sanandaji 08/04/2014
One factor that is often overlooked in the debate over causes of income inequality is a shift in ...
A Flawed E-Cigarette Regulation By Sally Satel and Alan D. Viard 08/16/2014
The FDA's proposed regulation should not go forward in its current form, or it will undermine ...
 
AEI