Thursday, April 21, 2011

The Debt Ceiling Crisis

Article I, Section 8 of the U.S. Constitution states that "the Congress shall have Power ... To borrow Money on the credit of the United States." Early in the nation's history, Congress passed a law each time the Treasury Department borrowed. By World War I that had become tedious, so Congress began to authorize Treasury to borrow up to a set limit. (See this source for details.) Ever since, Congress has periodically raised the debt ceiling as needed to finance federal budget deficits -- 69 times since March 1962.

Most of the time, bills increasing the debt ceiling have been politically mundane because the ceiling is usually, and rightly, seen as an EFFECT of federal budget deficits, not their cause. The CAUSE of deficits, of course, is Congressional authorization of expenditures that exceed revenues. Occasionally, however, some lawmakers convince themselves it is a good idea to render the debt ceiling a political football.

The debt ceiling has never caused the Treasury to default on its bonds but it has rendered Treasury operations precarious and uncertain on several occasions, including May-June 2002, February 2003, and October 2004. During those episodes, Treasury resorted to various legal accounting ruses to temporarily stave off default until Congress approved increases. (Essentially, it temporarily replaced bonds held in various intergovernmental accounts with "non-debt instruments," thus allowing it to borrow mo' money. After the ceiling increase, it swapped the non-debt instruments for its bonds once again, restoring the status quo pre factum, so to speak.)

Another debt ceiling crisis is currently brewing and it is shaping up to be a real rumble as Tea Party members and other fiscal conservatives hope to use the approaching ceiling to force large expenditure reductions. Using the debt limit as a political tool, however, is potentially dangerous. It backfired on Republicans in 1995 and could do so again because American swing voters (like yours truly) know full well that fundamental tax reform, even if it leads to higher taxes paid by some, should be on the table too. And most Americans understand that defaulting on the national debt, even if only "technically" and for a short time, is not a trifling matter, especially given the economy's continued weakness and China's positioning of its currency as an alternative reserve currency.

Fiscal conservatives have shot back that failing to decrease the debt limit does not mean that the government will have to default. The Full Faith and Credit Act (S. 163/ H.R. 421) would "require that the Government prioritize all obligations on the debt held by the public in the event the debt limit is reached." In other words, Treasury would be legally required to pay bondholders first. That, however, will look like another Wall Street bailout to many Americans when they learn that the government failed to pay its other creditors, like Social Security recipients and government employees and contractors.

There is, I believe, a compelling argument that it would be UNCONSTITUTIONAL for the government to purposely default on the national debt. I think the argument could be easily extended to its other creditors as well but, as usual, I will defer the point to experts in Con Law (which is not an oxymoron but an abbreviation).

What I will do instead is to submit that it would be highly INEXPEDIENT for the government to fail to raise the debt limit, whether its failure results in a default on its bonds or the non-, late-, or partial payment of its other creditors. Credit is like a tender flower in that it takes only one misstep to crush it forever. Governments interested in borrowing in the future (as all with any pretensions to anything like the preamble of the Constitution must be) should never incur financial obligations of any sort that they do not intend to pay as promised.

Alexander Hamilton, writing as Publius in Federalist No. 30, stated the same idea rhetorically: "Who would lend to a government, that prefaced its overtures for borrowing by an act which demonstrated that no reliance could be placed on the steadiness of its measures for paying? The loans it might be able to procure, would be as limited in their extent, as burthensome in their conditions. They would be made upon the same principles that usurers commonly lend to bankrupt and fraudulent debtors ... with a sparing hand, and at enormous premiums." And in a letter to Hamilton from William Bingham in November 1789: "A Government should therefore pledge every security it can offer, to engage the Confidence of the public Creditors, which, if once impaired, the pernicious Effects can be felt in all its future Dealings. ... The Credit of the Funds must essentially depend on the permanent Nature of the Security; & if that is not to be relied on, they will fall in Value, the disadvantage of which, Government will experience by the payment of an exorbitant Interest, whenever it is compelled to anticipate its revenues. .... Great Attention should be paid to the public Creditors, by making Such Proposals to them, as are consistent with the Principles of Justice & Equity. ... To take Advantage of their Necessities, would be to lose their Confidence." [And on and on and on in Hamilton's public writings and private correspondence.] In other words, failure to raise the debt ceiling could make it much more difficult and much more costly for Treasury to borrow in the future, when America may really need the money to fight a large war or rebuild a region ravaged by a natural catastrophe.

As I have said on this blog and in my books many times before, the federal government DOES need to get its fiscal house in order and the sooner the better. Playing roulette with the debt ceiling, however, is not the way to achieve it. At this crucial juncture America needs economic statesmanship, not financial brinkmanship. It needs policies that will energize entrepreneurs and increase productivity so that the government's debts -- all of them -- can be serviced according to contract more easily. But that would require a lot of thoughtful conversations, a good that again appears to be in short supply in Washington.

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