Tuesday, July 12, 2011

Questions & Answers to U.S. Debt Ceiling

1. What does increasing the debt limit mean for our average readers?
INCREASING THE DEBT CEILING WILL BE A NON-EVENT FOR THE AVERAGE AMERICAN. NOT INCREASING THE DEBT CEILING WILL HAVE SEVERAL SIGNFICANT IMPACTS. A) FIRST, THE U.S. WOULD NOT DEFAULT ON ITS DEBT OBLIGATIONS BUT WILL CONTINUE TO RETIRE MATURING BONDS AND PAY REGULARLY SCHEDULED INTEREST PAYMENTS. B) SECOND HOWEVER, THE U.S. TREASURY IN CONSULTATION WITH THE PRESIDENT WOULD HAVE TO PRIORITIZE GOVERNMENT OUTLAYS OTHER THAN OBLIGATIONS RELATED TO DEBT. THIS WOULD MEAN THAT SOCIAL SECURITY PAYMENTS COULD BE DELAYED OR U.S. GOVERNMENT VENDORS WOULD NOT BE PAID UNTIL THE SITUATION IS RESOLVED. C) THIRD, EVEN THOUGH THE U.S. WILL NOT DEFAULT ON ITS DEBT OBLIGATIONS, IT IS VERY, VERY LIKELY THAT YIELDS (INTEREST RATES) ON U.S. BONDS AND T-BILLS WOULD RISE DRAMATICALLY (I.E. GREECE, PORTUGAL) AS GLOBAL INVESTORS SEEK SAFTER BONDS SUCH AS THOSE OF SWITZERLAND.

2. What does employing the codicil in the 14th amendment mean, in terms of squaring it with the Congress’ Constitutional power over the purse?
TREASURY SECRETARY GEITHNER IMPLIED THIS PAST WEEK THAT THE FOURTEENTH AMENDMENT TO THE U.S. CONSTITUTION GIVES THE PRESIDENT THE AUTHORITY TO PUSH THROUGH AN EXTENSION OF THE DEBT CEILING WITHOUT CONGRESSIONAL APPROVAL. HOWEVER, THIS WOULD BE A RISKY STRATEGY SINCE THE ISSUE WOULD HAVE TO BE RESOLVED IN THE COURTS WITH INVESTORS LIKELY FLEEING U.S. BONDS THUS DRIVING INTEREST RATES HIGHER UNTIL THE SITUATION IS RESOLVED BY THE COURTS.

3. What does it mean to raise spending in relation to GDP? How does that affect consumers and the economy in general?
RAISING GOVERNMENT’S SPENDING RELATIVE TO GDP SIMPLY MEANS THAT A LARGER SHARE OF THE NATION’S OUTPUT IS COMPOSED OF GOVERNMENT SPENDING AND LESS OF PRIVATE SPENDING. THE PROBLEM WITH THIS SHIFT FROM PRIVATE TO PUBLIC SPENDING IS THAT PRODUCTIVITY GROWTH IS MUCH LOWER IN THE PUBLIC SECTOR THUS OVERALL U.S. ECONOMIC GROWTH WOULD BE SLOWED. THIS WOULD AFFECT ALL AMERICANS AS THEY WOULD EXPERIENCE SLOWER WAGE GROWTH, FEWER BENEFITS SUCH AS MUCH SMALLER RETIREMENT PACKAGES AND HIGHER INTEREST RATE. WE ECONOMISTS TERM THE IMPACT ON HIGHER INTEREST RATES—CROWDING OUT. AS THE GOVERNMENT DEBT GROWS, INTEREST RATES RISE WHICH DISCOURAGES BUSINESS INVESTMENT.

4. I’ll ask you to put your expertise in motion here: What would you do to resolve this situation?
I WOULD PUT A SIX MONTH PATCH IN PLACE UNTIL A TAX REFORM PACKAGE COULD BE PASSED. ONE ELEMENT OF THE TAX REFORM PACKAGE WOULD INCLUDE ENCOURAGING THE RE-PATRIATION OF CORPORATE EARNINGS. CURRENTLY U.S. CORPORATIONS HAVE OVER $1 TRILLION IN EARNINGS PARKED ABROAD. ENCOURAGING THESE CORPORATIONS TO BRING THIS REVENUE TO THE U.S. BY LOWERING THE CORPORATE TAX RATE ON THESE EARNINGS FROM 35% TO 10% WOULD ADD $100 BILLION TO CORPORATE TAX COLLECTIONS AND ANOTHER $42 BILLION IN DIVIDEND TAXES FROM INVESTORS. IN ADDITION TO THE $142 BILLION IN FEDERAL TAX COLLECTIONS, CORPORATIONS AND INDIVIDUALS WILL SPEND AND/OR INVEST THE NET REVENUES. ACCORDING TO MY ESTIMATES, THIS WILL GENERATE MORE THAN $800 BILLION IN CORPORATE INVESTMENT AND $32 BILLION IN INVESTOR SPENDING (DISALLOW STOCK BUY BACKS). THIS WILL PRODUCE U.S. JOBS AT THE SAME TIME IT FATTENS BOTH FEDERAL AND STATE TAX COFFERS. ABSENT THIS ACTION, CORPORATIONS WILL CONTINUE TO INVEST THESE FUNDS OUTSIDE THE U.S. CREATING NON-U.S. JOBS.

5. What if the “crisis” isn’t resolved before the August deadline?
NOT INCREASING THE DEBT CEILING WILL HAVE SEVERAL SIGNFICANT IMPACTS. A) FIRST, THE U.S. WOULD NOT DEFAULT ON ITS DEBT OBLIGATIONS BUT WILL CONTINUE TO RETIRE MATURING BONDS AND PAY REGULARLY SCHEDULED INTEREST PAYMENTS. B) SECOND HOWEVER, THE U.S. TREASURY IN CONSULTATION WITH THE PRESIDENT WOULD HAVE TO PRIORITIZE GOVERNMENT OUTLAYS OTHER THAN OBLIGATIONS RELATED TO DEBT. THIS WOULD MEAN THAT SOCIAL SECURITY PAYMENTS COULD BE DELAYED OR U.S. GOVERNMENT VENDORS WOULD NOT BE PAID UNTIL THE SITUATION IS RESOLVED. C) THIRD, EVEN THOUGH THE U.S. WILL NOT DEFAULT ON ITS DEBT OBLIGATIONS, IT IS VERY, VERY LIKELY THAT YIELDS (INTEREST RATES) ON U.S. BONDS AND T-BILLS WOULD RISE DRAMATICALLY (I.E. GREECE, PORTUGAL) AS GLOBAL INVESTORS SEEK SAFTER BONDS SUCH AS THOSE OF SWITZERLAND.

6. How valid are the comparisons to increasing the debt limit to consumers arbitrarily and unilaterally increasing their credit limit?
THERE ARE SEVERAL DIFFERENCES. LENDERS WILL ONLY ALLOW CONSUMERS TO RUN DEFICITS FOR A LIMITED AMOUNT OF TIME. THE FEDERAL GOVERNEMNT HAS NO SUCH CONSTRAINT (EXCEPT THAT IMPOSED BY POLITICS AS ADMINISTERED BY CONGRESS). THE FEDERAL GOVERNMENT CAN CONTINUE TO ADD TO THEIR ACCUMULATED DEBT. HOWEVER, THIS WILL SLOW ECONOMIC GROWTH AS INVESTORS DEMAND HIGHER AND HIGHER INTEREST RATES. HIGHER INTEREST RATES WILL CHOKE OFF ECONOMIC GROWTH. A SECOND OPTION AVAILABLE TO THE FEDERAL GOVERNMENT BUT UNAVAILABLE TO CONSUMERS IS THE FEDERAL GOVERNMENT’S ABILITY TO PRINT MORE MONEY. WE HAVE A SYSTEM OF FIAT CURRENCY. THUS THE FEDERAL RESERVE COULD BUY THE FEDERAL GOVERNMENT’S DEBT THEREBY PUTTING MORE CURRENCY INTO THE SYSTEM. OF COURSE, THIS RESULTS IN EXCESSIVE INFLATION AND MOUNTING STRESS ON THE BANKING SYSTEM.

Ernie Goss

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