They all assert that failing to increase the debt limit could sharply undermine the economic recovery.
But that view could be wrong. A temporarily frozen debt limit could instead signal U.S. lawmakers’ resolve to get our fiscal house in order. It may even reassure investors about long‐term U.S. economic prospects.
With the national debt at $14.27 trillion and rising, Congress must soon approve an increase in the legal debt ceiling — now at $14.29 trillion — so that the Treasury can continue conducting the nation’s fiscal operations.
Given the imbalance between obligations and revenue from taxes and other sources, the Treasury would technically be in default within a matter of weeks if it fails to obtain the legal authority to issue additional Treasury securities. Government officials fear that this outcome will cause financial markets to seize up and impede the economy’s fragile recovery.
Ordinarily, a Treasury default would have a considerable negative effect on international financial markets. This could be heightened now — given the potential for an early end to the Fed’s QE2 asset purchase program and continuing speculation about when (not if) the Fed will begin increasing its overnight borrowing rate.
Some private investors are already shorting Treasuries in anticipation of a decline in their prices. Others fear that if the debt limit is not increased soon, the expected gradual withdrawal from Treasury securities — the normal response during economic recoveries as investors begin to tolerate greater investment risks — may turn into a stampede.
How valid are these concerns? Not very.
Freshman House Republicans, however, insist that their mandate is to rescue the nation from the negative outlook that S&P is predicting could eventually cause a real debt default.
In contrast, the current prospect of a technical default, from failing to increase the debt limit, would not be due to any real national insolvency. Given today’s low interest rates, the federal government could easily raise the resources needed to meet today’s contractual government obligations.
The correct description for the technical default from Congress’ failure to increase the debt limit, therefore, should be “a temporary suspension of fiscal operations to promote a more prudent fiscal course.”
A failure to increase the debt limit now would just create an ersatz “crisis.” For too long, analysts and politicians have balked at the massive political impediments to reforming the federal budget — especially entitlement programs.
Many now concede, actually, that no prudential reforms are likely unless there is an imminent “crisis.” On the other hand, political liberals argue that there is no real “crisis” — and so no need for real reforms.
Well, here’s the opportunity for a “crisis” that “should not be wasted.” It would be a real crisis for those urging caution — given what they believe. And it would be an ersatz crisis for others — who believe in the salutary effects of crises on fiscal policies.
Given its purpose is to avoid a real future crisis, by bringing to heel run‐away spending on entitlements and other wasteful government programs, here’s an opportunity for experiment: Would a debt‐limit “crisis” beget better fiscal policies?
How might investors really view this ersatz U.S. debt crisis? If some lawmakers’ refusal to vote for increasing the debt limit without also passing prudential fiscal policies resulted in a technical U.S. default, it would demonstrate their significant political strength.
Might that not actually induce investors to buy long‐term U.S. debt — reducing long‐term interest rates and improving the U.S. investment climate?
Indeed, investors should be fearful of the opposite: an increase in the debt limit without a serious challenge from reform‐minded lawmakers. This only signals business as usual for U.S. fiscal affairs.