We shouldn’t dread the debt limit

“Have a drink out there, folks, and just know that your kids and grandkids will be out there picking grit with the chickens,” says former U.S. Senator Alan Simpson in the video above. Simpson’s quip is the best summary I’ve ever heard of the public’s lack of understanding of the severity of the nation’s fiscal crisis. The federal government is currently borrowing 42 cents of every dollar that it spends. Thanks to the Federal Reserve’s quantitative easing and the strong global demand for U.S. Treasury debt, the nation has been able to borrow heavily at low interest rates to cover its budget shortfalls.

But the debt is piling up so high that the country might face a borrowing shock if there were a black swan event or if bond vigilantes forced higher interest rates. It’s not a question of whether rates will rise – they certainly will. What we don’t know is when it will happen. The same politicians who created this fiscal quagmire have now tasked themselves with fixing it. Despite numerous proposals on how to get our debt under control, the political dynamics of the issue make it likely that nothing will be resolved in Congress until after November’s election. The Washington Post reports:

But once the election is over … the issue of the debt will quickly rise to the top of the agenda – and not just because of the debt limit. In January, policymakers also will be facing the first round of harsh, across-the-board spending cuts adopted last summer, as well as the expiration of a host of tax cuts that benefit every American household. Unless Congress agrees on an alternative deficit-reduction strategy, the policies threaten to deliver a fiscal shock that could throw the nation back into recession.

Earlier this week at the Peterson Foundation’s Fiscal Summit 2012, House Speaker John Boehner gave a speech in which he laid out his plans for tax reform and vowed not to increase the borrowing limit:

Any sudden tax hike would hurt our economy, so this fall – before the election — the House of Representatives will vote to stop the largest tax increase in American history [the expiration of the Bush tax cuts]. This will give Congress time to work on broad-based tax reform that lowers rates for individuals and businesses while closing deductions, credits, and special carveouts. Eyebrows go up all over town whenever I talk about this, but when I say ‘broad-based’ tax reform, I mean it. We need to do it all … deal with the whole code, personal and corporate it’s fairer and more productive for everyone.

The United States enters the twilight zone

ZeroHedge points out that the amount of U.S. debt outstanding has just surpassed the latest reading of our gross domestic product:

There is nothing quite like a $70 billion debt auction settlement at the last day of a month to bring total US debt to a record $15.692 trillion, which happens to be just $600 billion shy of the $16.394 trillion debt ceiling … And now that we know what Q1 GDP was at the end of Q1, or namely $15.462 trillion, it is simply math to divine that today alone total US/debt to GDP rose by 50 bps to a mindboggling 101.5%.

Now there is a whole school of thought, which counts New York Times columnist Paul Krugman among its leaders, that says that despite the amount of debt the federal government has incurred, more government spending and debt are needed given the stagnant state of the economy. Krugman elaborated on this idea in a recent interview with Julian Brookes of Rolling Stone:

Continuing wills for the United States?

The theatrics in Congress concerning the debt ceiling, now in their seventh month, have sent increasingly strong shock waves throughout the U.S. and global financial systems. The debt ceiling is the legislatively-imposed limit for the nation to issue debt to fund its activities. It’s been stalled at the same level of $14.3 trillion since May 16. The U.S. Treasury has been scrambling to find extra monies, including borrowing internally from the federal government workers’ pension plans, so that they can continue to pay the nation’s obligations. They say the cash drawer is near empty.

The United States borrows or issues debt for 40 cents of every dollar that it spends — that is a lot to borrow. The federal government turns around and distributes this borrowed money, along with taxes collected, to Social Security and Medicare beneficiaries, states and local governments and defense contractors. It also returns some of it to bond holders as interest payments. The federal government is so massive that this flow of payments equals about 24% of the gross national product. If this flow stops, substantial parts of the economy will stop.

Organizations that oversee, or participate in, the financial system are rightly concerned. One positive benefit of these long, drawn-out Congressional deliberations is that there is time for extensive planning and analysis. Credit rating agencies have particularly been concerned with the downstream effect on state and local governments. Today Moody’s issued a press release that affirmed the strong AAA rating of 400 local governments while saying it would review the AAA rating of 162 other local governments (emphasis mine):

Debt loads

The panic surrounding municipal debt rarely references data from other government bodies, such as the debt of the U.S. federal government or European states. If we compare state debt loads to the sovereign liabilities of Western developed countries, they look eminently manageable.

One of the first posts I wrote for Muniland was about the relative debt loads of the states and the federal government:

To help us understand on a quantitative basis we have some useful data from the Securities Industry and Financial Markets Association (SIFMA). The data tells us that the municipal market is shrinking on a relative basis to other fixed income classes. Quelle surprise!

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