Debt Ceiling = Impending Doom? - Analyst Blog

Are we heading toward a new economic upheaval? That's the idea we get from the U.S. Treasury Secretary Timothy Geithner's expectation cited in Reuters last Thursday. According to Geithner, the federal government may knock the current $14.3 trillion debt ceiling by March 31.

As the government's current debt is just $333 billion shy of the ceiling, an immediate action to push the ceiling further up is essential to save the country from defaulting on its obligation, Geithner said.

Raising the ceiling is not new or unusual. Rather, this has become a Congressional drill to keep the government afloat. However, considering that the government debt is independent of the other fiscal policy measures, probably there will be no solution to the debt issue in the long term. Without changing the tax-cut policy, which does not match government spending cuts, the demand for raising the debt ceiling will automatically increase.

As usual, at the eleventh hour, the government is worried about the negative economic consequence of exceeding the debt ceiling. But no one seemed too uptight back when an opportunity to cut spending and keep the budget within the current debt limit was on the table, so this outcome was almost inevitable.

We understand that government spending in the form of several stimuli was a prerequisite to stabilize the financial system. However, these initiatives should not have been taken at the cost of mounting national debt. The government should have taken additional policy measures to control spending and resist deterioration in budget deficit.

The New Year has kicked off with the debt ceiling issue being in hot debate. Let's take a quick look at the fundamentals of debt ceiling to understand the problem at the root.

The Story Behind

Basically, debt ceiling is an upper limit on the amount of debt the federal government can borrow to operate economic activities of the country. A law for debt ceiling was passed by Congress in 1917 to simplify access to funding.

The primary purpose of setting the debt ceiling is for accounting assessments that are required to control the budget deficit. Based on the policies in place and related costs, the government settles on the amount it needs to borrow for a given period. Accordingly, it sets the debt limit, which helps control spending.   

According to the Congressional Research Service, the debt ceiling has been raised 74 times since March 1962. The ceiling was last set at $14.3 trillion in February 2010 and the government debt stands at $13.9 trillion as of January 4, 2011.

The Possible Outcome

If the U.S. hits the debt ceiling, it would preclude the authority from borrowing any more funds. As a result, the country, already neck-deep in loans, would be in a fix while attempting to pay them down. Funding its operations and paying creditors would become unfeasible. The ramification of lapsing loan obligations would then malign the domestic environment and spread the condition internationally.

Additionally, this would pull down America's credit rating, making it difficult for the country to continue borrowing money from other countries. The country would face a serious debt crisis, perhaps akin to Greece, Mexico, and Argentina, which are still struggling to even out.

Is a Delay Possible?

According to government officials, Treasury could delay hitting the limit by taking extraordinary actions like suspension of government securities sales, reduction of financing program or plummeting some pension funds. However, the upshot will not change.

According to Geithner, ultimately, the government would not be able to pay interest on its debt, pushing the economy in dire straits. The situation could perhaps become even worse than the latest recession.

Is This a Political Drama?

Going by history, this whole new episode of debt ceiling is yet another political play.

While some Republican lawmakers are against raising the debt ceiling without dealing with government spending, others recognize the need to allow the government to act otherwise. Though Republicans won control over the House of Representatives in the November General Election with a promise to address the debt issue and cut government spending, they  now look as if they may compromise on the debt front.

On the other hand, though the Obama administration knows that knocking the debt limit would be disastrous on the economy, it is unable to implement a spending cut as this would curb economic recovery.

Political parties can fiddle with the issue as per their wishes. If a party wants to keep the issue alive, it will give the ceiling a slight nudge so that the question surfaces soon. Adversely, there will be a big push in case a party wants to avoid the debate for a long time.

Government Spending Gone Awry

Though the government did not cut spending to continue with its monetary and fiscal stimuli that were obligatory to helping the economy get back into place, many U.S. companies are just manipulating policies to mint more money and remain competitive in the free trade marketplace, injuring the livelihood of middle-class Americans.

With the government supported economic recovery, the U.S. companies are hiring employees out of the domestic periphery to stay competitive. For most of the U.S. companies, international demand for goods and services is growing much faster than the domestic requirement.

The Coca-Cola Company (KO), DuPont Fabros Technology Inc. (DFT), United Parcel Service Inc. (UPS) and Caterpillar Inc. (CAT) are among the U.S. companies that have created significant jobs out of the country in recent years.

It's time the companies give serious thought to U.S. workers. Under the existing policies, job movement to foreign countries will continue, pushing the U.S. economy to a riskier zone.

What is Likely to Ensue?

It is almost certain that Congress will raise the debt ceiling prior to knocking it. If we are to go by past records, this should tidy up economic mess related to the debt issue for the next few years.

However, in order to gain Republican support, the government will have to figure out some spending cuts, which will again moderate the efficacy of its stimulus packages.

A Catch-22 Situation

If the government withdraws the monetary and fiscal stimulus to control spending too soon, there is the risk of regressing into another financial crisis. Then again, fiscal strictness is called for in a country wading in pools of debt and deficit.

On the other hand, if the government continues the stimulus for a long period, the rising fiscal deficits may lead to a sovereign debt crisis. This could again threaten the economic recovery.

Increasing the ceiling definitely enables the government to continue borrowing, but this raises concerns related to debt escalation rather than providing a debt solution. Instead, greater efforts to pay down the debt or spending less would be a more feasible way out.

But then again, cementing the ceiling where it is would forbid the government from borrowing further to fund its obligations. This would subsequently lead to a more immediate economic mess.

Raising the ceiling should be viewed as an effort to buy some more time in order to address economic problems. However, the government should use this time wisely to control spending.