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The Dangers In Hitting The U.S. Debt Ceiling

January 8th, 2013

Ben Gersten: With the fiscal cliff deal behind us at last, the next big battle in Washington will focus on the U.S. debt ceiling, and the stakes are high.

The United States officially hit the $16.394 trillion U.S. debt ceiling Dec. 31. The debt now stands at about 73% of U.S. gross domestic product and will continue to rise over the next decade without major spending reforms.

Now the U.S. Treasury Department has decided to employ what Treasury Secretary Timothy F. Geithner calls “extraordinary measures” in the next two months to avoid actually defaulting on debt. Those measures include temporarily stopping the reinvestment of federal employees’ retirement account contributions into short-term government bonds as well as other steps to discontinue debt issuance.

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The new deadline for resolving the debt ceiling issue looms at the end of February, giving Congress little time to regroup after partly resolving the fiscal cliff.

“Do not forget that the fiscal cliff is only one of three upcoming problems in our ongoing fiscal madness,” Money Morning Chief Investment Strategist Keith Fitz-Gerald said. “There’s still the debt ceiling, sequestration and the complete lack of a budget to contend with. In other words, it’s on to the next crisis now.”

Dangers in Hitting the U.S. Debt Ceiling

The last time the country approached the U.S. debt ceiling, in 2011, it came close to defaulting on its debt and had its AAA credit rating stripped by Standard & Poor’s for the first time ever.

S&P at the time said “political brinksmanship” in the debt ceiling debate had made the U.S. government’s ability to manage its finances “less stable, less effective and less predictable.”

The previous budget battle actually led to an agreement to impose across-the-board spending cuts, known as “sequestration,” on Jan. 1, 2013, as well as implement tax increases – together known as the fiscal cliff.

If no U.S. debt ceiling deal is reached this time, the country will most likely receive credit rating downgrades from multiple rating agencies, sending equity markets into a tailspin and the economy back into a recession.

If the country defaults, a very real possibility, it would essentially have to choose what expenses and debts to pay and which can wait. The Treasury’s inability to make some payments could cripple the global banking system, which has a huge stake in U.S. assets and the dollar.

A default would also delay or stop Social Security and unemployment benefits as well as military service members’ checks, and unemployment and inflation would rise.

The Heated U.S. Debt Ceiling Debate

In 2011, when the country was on the brink of default, the debt limit was raised after U.S. President Barack Obama agreed to $1 trillion in immediate spending cuts and another $1.2 trillion in cuts set to kick in this year.

This time, the president has made clear he does not want to engage in any more political brinksmanship over the debt ceiling.

“While I will negotiate over many things, I will not have another debate with this Congress about whether or not they should pay the bills they have already racked up,” President Obama said in remarks at the White House.

This time, Republicans want debt limit increases to be matched dollar-for-dollar with spending cuts, while President Obama and fellow Democrats insist on implementing both spending cuts and tax hikes.

“If Congress refuses to give the United States government the ability to pay these bills on time, the consequences for the entire global economy would be catastrophic – far worse than the impact of a fiscal cliff,” Obama said.

Yet Republicans now appear more ready than ever to push the country into default and accept the consequences.

“Our opportunity here is on the debt ceiling,” Sen. Pat Toomey, R-PA, said on MSNBC, adding Republicans would have the political leverage against Obama in that debate. “We Republicans need to be willing to tolerate a temporary, partial government shutdown, which is what that could mean.”

Republicans are hopeful they can use the debt ceiling as leverage to force President Obama and fellow Democrats to accept major spending cuts to entitlement programs such as Medicare and Social Security.

“Without meaningful reform of entitlements, real spending controls, and a fairer, cleaner tax code, our debt will continue to grow, and our economy will continue to stumble,” House Speaker John Boehner, R-Ohio, said in a statement after the House vote on the fiscal cliff deal.

What’s the Likely Outcome?

The easiest resolution and perhaps likeliest scenario to end the debt ceiling debate is to simply raise the limit, which has been done 75 times since 1962.

That would postpone the chance of the U.S. defaulting on its debt and may prevent another downgrade, but do nothing to solve the issues at the core of the nation’s fiscal problems.

If Congress can do more than just kick the can down the road again, a deal might be passed that raises the debt limit, tackles some of the automatic spending cuts and makes minor adjustments to entitlement programs.

And the best outcome, but least likely, given the actions of Congress over the past two years, is that along with raising the debt limit, major spending cuts in defense and other programs are enacted, as well as reforms to Medicare, Medicaid and Social Security.

Ultimately, the U.S. debt ceiling will have to be raised, and both Republicans and Democrats know this, but it’s unclear whether they’ll reach any compromise, and even if they do, it might not prevent another credit rating downgrade.

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Written By Ben Gersten For Money Morning

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