The president and Congress have been unable to negotiate a compromise relating to an increase in the national debt ceiling. The U.S. must have more capacity to borrow funds, as the country’s revenues (from taxes and such) are less than its expenditures (for debt service, entitlements, etc.). House Republicans have indicated that they will not increase the ceiling unless it is accompanied by a plan to dramatically reduce future spending by the federal government.
Complicating the issue are Tea Party Republican House members who have refused to vote for House Speaker John Boehner’s (R-Ohio) plan. Their refusal to comply is based upon a demand for even greater spending cuts than those that have been proposed by the Boehner.
One of the most disturbing aspects of this political battle is that Republicans have made the approval of the debt ceiling a global financial issue. In the past, increases to the ceiling were routine. Now it is possible the ceiling will not be increased in time to enable the U.S. Treasury to pay all its obligations.
From the Republican perspective, this ploy has enabled them to bring one of their signature issues to the forefront and apply leverage to reduce the size of the federal government, a long-time conservative objective.
Regardless of where you stand on the issue of government spending, creating a crisis that could have such far-reaching, long-term consequences is a reckless act. Both political parties have fanned the flames of partisanship during the months of debate on this issue making it impossible to negotiate a compromise.
But, what will happen if an agreement cannot be forged before August 2? This question needs to be considered from two perspectives — the practical and the intangible. From a practical point of view, if the U.S. cannot borrow additional funds, it will need to prioritize near-term payments with its incoming cash (as mentioned previously, expenditures far exceed cash receipts). Prioritization would be a brutal task that screams for the involvement of the Treasury Secretary, the president and Congress. Frankly, it is unprecedented how decisions might be made whether to pay Social Security, federal government salaries or military expenses if insufficient funds were not available to pay them all. This dilemma should be enough to encourage the president and Congress to come to an agreement before the clock runs out next week.
The intangible issues of a default would have a huge financial impact. If the U.S. were deemed to be insolvent, even for a short period of time, its debt rating would be lowered; the resultant higher cost of funding would increase the nation’s cash flow imbalance. A lower debt rating might also trigger a sale of existing Treasury securities, which would increase the cost of future funding even more. Further, the financial reputation of the U.S. and its currency would be soiled by its inability to manage its finances.
The easiest resolution of the crisis would be for Congress to vote on a short-term increase in the debt ceiling, if it cannot come to a more comprehensive agreement before the 2nd. The next most probable resolution would be a compromise between moderate Republicans and Democrats to accept Sen. Harry Reid’s (D-Nev.) plan, which among other things would extend the debt ceiling beyond the 2012 election and provide serious spending cuts (but no tax increases). The long shot, it appears, is approval of the Boehner plan, which is for six months and requires more haggling over spending cuts between the president and Congress beyond that point. However, the cooperation of the Tea Party members of the House of Representatives is doubtful and the proposal is “dead on arrival” at the Senate according to Senate leaders.
By not being able to complete a deal on the debt ceiling and endangering the nation’s financial reputation, Republicans have lost their political advantage. Boehner has not been able to effectively lead his caucus and most of the conservative freshmen in the House will have trouble getting reseated in 2012. This situation might be one of the greatest political miscalculations in history, and it will likely seal the reelection of a weak Democratic president.
Photo Credit: Bilal Lashari