The next fiscal fight: From cliff to ceiling
The debt ceiling in America serves no useful purpose and should be abolished
Jan 12th 2013 | from the print edition
Most of the time, the debt ceiling has been an annoyance, affording whichever party was out of power the opportunity to extract concessions before allowing normal borrowing to resume. It may even have done some good by raising the political price of deficits. But as American politics has become more polarised, it has become an instrument of mass financial destruction. In the summer of 2011 Republicans openly used the threat of default to force Mr Obama and Democrats into a deficit-cutting deal. The episode prompted one credit-rating agency to strip America of its triple-A rating. Republicans, furious that in the recent tussle over the “fiscal cliff” they caved in on tax increases and have no spending cuts to show for it, are spoiling for another fight. Defiant Democrats are floating crackpot responses such as issuing a $1 trillion coin to avoid the debt ceiling (see article) or invoking the 14th amendment to the constitution, which they say forbids default.
The Treasury could try to soften the blow of hitting the debt ceiling by making interest payments on its debt the priority while leaving some other bills unpaid. Yet that would still wreak havoc. The federal government now borrows nearly 30 cents of every dollar it spends. Failure to raise the debt ceiling would force immediate spending cuts equal to 6% of GDP. Not only would that threaten to send the economy back into recession. It would also deprive doctors, pensioners, contractors and millions of others of money needed to meet their own obligations, setting off a chain reaction of defaults.
Nor would the sanctity of the debt be guaranteed. Disgruntled creditors could challenge the legality of prioritising interest payments; populists could demand that Chinese bondholders be paid last, not first. One miscalculation could leave the Treasury without enough money to make an interest payment. Even a few days’ default would roil the global financial system, which relies on Treasuries in countless transactions. The mere possibility could incite skittish investors to dump their holdings, driving up interest rates.
The debt ceiling long ago outlived its usefulness. Congress already has the final say over the budget. And Republicans looking for leverage have alternatives. These include the threat of almost $90 billion of annual spending cuts due to take effect in March and, soon afterwards, the possibility of letting the authorisation for a chunk of federal spending expire, forcing the government to shut down. Though hardly ideal, both would be less destructive than default. If instead Republicans wage another fight over whether America should meet its legal obligations, they will reinforce the impression that the country can no longer be trusted. Better to scrap the debt ceiling now.
The original article is linked here.