Depending on which side of the political aisle you sit on, the whole US debt ceiling business is either a global financial Armageddon waiting to happen or a political mirage that serves as an excuse to raise taxes and preserve Big Government.
With US debt set to exceed the self-imposed $14.3 trillion cap on August 2, Congress needs to approve an increased limit, or it will not be able to access additional funding to keep the wheels of government turning.
A debt reduction plan is seen as necessary for gaining Republican support of legislation that would increase the debt ceiling. US President Barack Obama has been pushing for a $4 trillion deficit reduction plan over 10 years that would mix spending cuts with taxes on the wealthy and corporations. But House Speaker John Boehner, a Republican from Ohio, made a dramatic announcement on Saturday evening that he would support a package that dialed-down debt reduction to $2 trillion, and which does not involve any new taxes.
The severity of what will happen if a deal on raising the debt ceiling is not struck by August 2 is hotly debated.
US Treasury Secretary Tim Geithner famously warned in January that a failure to raise the debt ceiling would result in government default of debts that would spark "catastrophic economic consequences that would last for decades."
Meanwhile, Republican presidential candidates have been downright dismissive. Congresswoman Michele Bachmann, a Minnesota Republican who is also running for president in 2012, has called the threat of default mere "scare tactics."
And according to Michael D. Tanner, a senior fellow at the conservative Cato Institute, “If the government is not able to borrow more money after Aug. 2, spending will have to be reduced to the amount of revenue that the government has. That would require roughly a 44% cut in federal spending. This will almost certainly hurt. But it’s not the same as default.”
Despite the bombastic back-and-forth between the two political parties, there’s general agreement—with the notable exception of Bachmann—that the debt ceiling must be raised, or there will be financial consequences to the country and the global markets.
Newly minted IMF chief Christine Lagard told Bloomberg that it would be "a real shock" if the US did not resolve the debt ceiling issue because it would cause interest rates to jump, and result in “stock markets taking a huge hit, and real nasty consequences, not just for the United States, but for the entire global economy, because the US is such a big player and matters so much for other countries."
During a Monday press conference, Boehner acknowledged that the national debt limit “must be raised.” But he did not agree with the president on how to go about reducing the debt.
The American people will not accept, and the House cannot pass a job-killing tax hike. We cannot allow our nation to default on our debt... But a bill that does not meet these tests cannot pass the House of Representatives.
Some conservatives have, in fact, argued that defaulting could be a good thing for America because debt enables Big Government.
The Obama administration, on the other hand, believes that the wealthy and corporations will have to step in to help resolve America’s borrowing problem. He is also seeking to minimise cuts to "entitlement programs" such as Medicare and Social Security.
According to the White House Communications Director:
The President believes that solving our fiscal problems is an economic imperative. But in order to do that, we cannot ask the middle-class and seniors to bear all the burden of higher costs and budget cuts. We need a balanced approach that asks the very wealthiest and special interests to pay their fair share as well, and we believe the American people agree.
During a Monday press conference, Obama also clarified his position on generating revenue (which Republicans refer to as tax hikes):
I want to be crystal clear—nobody has talked about increasing taxes now. Nobody has talked about increases—increasing taxes next year. What we have talked about is that starting in 2013, that we have gotten rid of some of these egregious loopholes that are benefiting corporate jet owners or oil companies at a time where they're making billions of dollars of profits. What we have said is as part of a broader package we should have revenues, and the best place to get those revenues are from folks like me who have been extraordinarily fortunate, and that millionaires and billionaires can afford to pay a little bit more—going back to the Bush tax rates.
Officials entered into another meeting at the White House on Monday to continue to seek a resolution on the debt ceiling.
Debt and politics
None of this is unchartered territory. The US Congress has increased the debt ceiling numerous times throughout history, and most recently in February 2010.
But following a global financial crisis, what would have been an automatic maneuver in the past has become an issue for scrutiny. The country’s debt as a percentage of GDP—60%—is also higher than the 40% historical rate.
Clearly, America has a spending problem. But how to resolve it has become a battle of ideology that’s being conflated with budget priorities in a challenging economy. Hence the current political dog and pony show.
The Canadian solution
But the question remains: How should the US trim its debt burden? Wall Street bond dealers and money managers told Reuters that spending cuts alone won't fix the US debt problem, which has grown in recent years thanks to spending on the wars in Iraq and Afghanistan under both Republican and Democratic administrations, among other expenditures.
In other words, trying to reduce the national debt simply by cutting spending is a bit like trying to pay off a maxed-out credit card by trimming how much you spend at the supermarket this month.
Kelly Philips Erb, a Forbes columnist, recently made a similar argument and she came up with a novel suggestion that would allow the Democrats to keep entitlement programs intact while preventing any tax increases. To make both political parties happy, she suggested, "invade Canada and take over their Treasury."
Sounds ridiculous, but when politicians are more interested in preserving ideologies than in genuine problem solving, insanity is about all that’s left.