Shutdown, default and the debt ceiling

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The refusal by the Republican majority in Congress to raise the ceiling on federal debt means that, on the one hand, they think this issue is so important they are willing to put the functioning of the federal government at risk, but, on the other hand, they are unable to come up with a plan to actually bring the budget under control, and so leave it to President Obama to figure out.

A lot of people who discuss this issue assume that this would mean that the federal government would default on its existing debt.  A default would be catastrophic.  U.S. government bonds would no longer be considered an absolutely safe investment, which means the Treasury Department would have to pay more interest to attract lenders.  This would not only mean the federal debt would compound at a faster rate.  It would push up U.S. interest rates generally.  It would be more expensive to take out a car loan, a home mortgage or a small business loan.

Fortunately there are other options.

The most likely option would be a partial shut-down of the federal government.  I can’t guess what would be cut.  Presumably the military and Homeland Security would be exempt.  Would the national parks be closed?  Would the Postal Service suspend or reduce mail deliveries?   I don’t know.  Would it be legal to reduce or suspend payments for Social Security, Medicare and other so-called entitlements programs mandated by law? I don’t know.  Would federal employees have to take a pay cut or suspension of wages? Maybe.

Another possibility would be that the Federal Reserve system would simply create money to pay down the national debt.  That, in fact, is the normal mechanism by which money is “printed.”  It is what was done with “quantitative easing.”  I can’t guess the long-term consequences of this would be, but it doesn’t seem like a good idea.  But it is an option (if the Fed agrees – admittedly, a big “if”).  Creating money by buying Federal bonds would provide a means to keep the federal debt within the legal limit while continuing the normal operations of the federal government.

The final possibility is that President Obama would simply refuse to comply with the debt ceiling on Constitutional grounds.  But such a confrontation wouldn’t be his style, and the Constitutional argument seems weak to me.  It rests on Section 4 of the 14th Amendment states that “the validity of the public debt of the United States, authorized by law … shall not be questioned.”  But it is an option.  He could make his Constitutional claim and see what the courts say.

I think any serious attempt to deal with the deficit problem would entail (1) increasing government revenues, (2) reducing military spending and (3) restoring a full employment economy.  Cutting off Social Security and Medicare to 85-year-old widows isn’t going to solve the problem.

Click on America’s debt: The debt ceiling and default for analysis of options by The Economist magazine.

Click on Debt Ceiling Doomsday: How Flirting with Default is Playing with Fire for an interview with Bo Cutter, who was director of the National Economic Council during President Clinton’s first term.

Click on The Political Winners and Losers of a Debt Ceiling Showdown for the second part of the Bo Cutter interview.

Click on Why Policymakers Should Ignore the Debt Ceiling for analysis of legal options by Marshall Auerbach of the Roosevelt Institute.

Senator Barack Obama in 2006 voted against raising the debt ceiling.  President Obama says he regrets that vote, as well he should.  But at least the Democratic opposition back then had sense enough to back down before the government had to shut down.

P.S.  I challenge those who want to cut “spending” in general to specify what governmental activities or programs they would eliminate or reduce.

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Tags: Debt ceiling, Debt default, Federal budget, Federal deficit