Thoughts on the Debt Limit

I’ve held off commenting on this one so far because I’m still considering how it might affect all of us. On the one hand, I fully recognize the dangers of not increasing the debt limit. On the other, I fully recognize the dangers of letting debt continue as a policy for this nation.

But first, a history lesson….

Without getting technically boring and overbearing, the debt ceiling was a modern invention designed to allow the United States to handle its finances in a way more inline with how things are done today. Well, back then. This is the first half of the last century we are talking about, after all. Prior to that time, debt was issued individually under the approval of Congress. I’m sure we can all agree that making individual requests from Congress is much more time consuming that simply having a pre-set debt limit within which the Treasury could work.

Now that you understand that, can you see how the debt limit (debt ceiling if you want to call it that) was never really intended as a maximum cap for the nation’s debt? More than anything, the debt limit was designed as the boundaries of a sandbox for the Treasury.

At least that was the intent.

As the nation’s debt grew, the original purpose of the debt limit (allowing the Treasury to act as it best saw fit within a defined limit) has become a bit confused with the idea that it was intended to be a true cap on spending, a protection from rampant deficits and debt. If that were ever the case, it has obviously failed.

Now with that history under your belt, can you see why it’s a little difficult for the Republican party to try to use the debt limit as a tool to force mandatory caps on spending? At the same time, can you see how it is difficult for the Democrats to argue that the debt limit must be raised for the  government to function? Basically both parties are shifting the original intent and design of the debt limit to meet a specific goal and need that they see as valuable.

So on to the debt limit today….

Treasury Secretary Timothy Geithner is firmly of the belief that hitting the debt limit, which we already have by the way, is a dangerous move. Right now, he is using a system of fund shifting to balance the budget. In particular, he is pulling money from future-funded accounts to pay bills today. In his opinion, he can continue to do so until early August, at which point the government will not have the funds necessary to pay contractors AND cover the interest on the debt.

And he’s right.

Should we arrive at that August morning without the ability to pay our debt obligations, we will default on the national debt. And I’ll talk about what that does to us in a moment.

The opposition to Sec. Geithner points out that we have another option to default, and that is to issue IOUs to the numerous contractors, programmers, and other creditors. This is very similar to what was done in California some years ago. While certainly an option, it also has consequences, which I will also address later on.

So what happens if we default?

Well, what happens if you don’t pay your car payment or your house payment? In the grand scheme of things, a default on the national debt is at least a little similar to a personal default. Does the world end immediately? No. But do the creditors start calling all day long? Yes. Do you lose a bit of control over your life? Yes. Does the cost of new debt go up? Yes, and significantly so. Does the debt go away? No.

Maybe the most important question is if we’ve done ourselves any favors, and that’s a clear no.

So the U.S. defaults on the debt. One of the first things that will happen is that we will lose access to the debt markets. In short, we won’t be able to get new debt for a time. Another early event is that we’ll lose our credit rating, meaning that any new debt will be issued at significantly higher rates. Much like you do when you refinance your house to a lower rate, the Feds have made it a practice of shifting debt from interest rate to interest rate, and that option will pretty much die in the event of a default. As long as we have good rates, no problem, right? But some of our higher interest debt will likely lock in at the higher rate, and any refinancing we do in the future will definitely have a higher rate.

The big issue here is that our long-term ability to manage our debt–meaning pay the interest on it–will be severely limited. As is, we will have significant difficulty paying the interest on the debt we already have. If we default, expect the interest on our debt to rise, potentially significantly.

In a nutshell, a default will cost this nation the ability to grow and expand. It will increase our expenses and limit our ability to provide services. To put it in to perspective, it’d be similar to you having to sell your second car and put that vacation on hold. It means no more trips to the movies, taking a second job, and probably cutting out the private school and sports for junior until you’re back on track.

Make sense? It’s bad, not fun, and uncomfortable.

So what happens if we just stop paying contractors?

Well, this is admittedly less disastrous than an outright default, but the complications are similar. Again, let’s put this into context of your own life. Suppose you’ve hired a contractor to build a new addition on your house. You’ve promised him $50,000, paid him $10,000 up front with four installments of $10,000 each promised over the next four months. In month 2, when he’s 40% done with the work, you don’t pay him. Do you think he shows up to work tomorrow? The week after? Ever?

The risk of sending IOUs to our contractors is that the infrastructure of the United States could grind to a halt. We have obligations, and we’ve agreed to those obligations. Sending IOUs creates a trust problem. Of particular concern would be the foreign investments that would recognize that trust problem and perhaps take business elsewhere. After all, do you think you could find a second contractor to pick up where the first one left off, especially if he knew what happened to the first?

Not a chance.

In a nutshell, sending IOUs stops the economy of this country in its tracks. I feel very comfortable stating that IOUs sends this nation straight back into a recession.

And what would I do?

Such a hard question…. On the surface, I am morally opposed to debt. I hate debt. Debt is bondage, and the current debt loads of this nation are such that we’ve sold our grand children into slavery.

On the other hand, defaulting on the debt or issuing IOUs will be equally destructive.

As much as it pains me to say it, the debt limit must be raised. It must. Any other action is immediately negative for our country. Having said that, though, I sincerely hope that our politicians recognize that not getting the debt under control is a long-term negative for our country.

Raising the debt limit is a must for right now. It must happen, but I also believe that it must come in conjunction with firmer controls on spending, a strong mandate to restore the debt limit to its original intention, and a legitimate plan for paying down our debt (not just limiting the deficit).

So much of what I’ve talked about in this post has tried to make things personally applicable to us. If I may one more time…. Take ten seconds and quickly add up all of your monthly outflows for debt purchases. That would be your car payment, your mortgage, student loans, credit cards, and so on. Got it? That number right there would be a rough equivalent of extra cash you would have today if you were debt free. What could you do with that? Sit back and imagine your life with that extra money every month. Pretty nice isn’t it?

Now realize that the United States through the month of May has spent $275,000,000,000 (that’s billion in case you’re wondering) on interest payments this year. That’s not paying down the debt, that’s just maintaining the debt we already have. By the end of the year, that number will cross the $600BB mark. By the end of the decade, that number will be over $1,000,000,000,000 (that’s a trillion). Annually.

You want to see stimulus? You want to see a bailout? Just imagine what having that burden taken off your shoulders would feel like. Just imagine what this nation could do and become if we didn’t have that debt load.

Now are you ready for the big number? If the U.S. could refund only the interest payments that it will spend on debt this year to you, you would get a check for roughly $1,929.

Think about it.

So yes, the debt limit must be raised. And yes, we have got to get it under control before we have all control taken from us.

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