Analysis: How We Got Here and Why We Must Raise the Debt Ceiling

Jul 05 2011 Published by under Uncategorized

A government deficit can be thought of as consisting of two elements, structural and cyclical.

At the lowest point in the business cycle, there is a high level of unemployment. This means that tax revenues are low and expenditure (e.g. on social security) high. Conversely, at the peak of the cycle, unemployment is low, increasing tax revenue and decreasing social security spending. The additional borrowing required at the low point of the cycle is the cyclical deficit. By definition, the cyclical deficit will be entirely repaid by a cyclical surplus at the peak of the cycle.

But by blocking all initiatives to create jobs while insisting on massive cuts to social welfare provisions, and domestic spending in education, health care, infrastructure, and the energy sector, Republicans — at the behest of their corporate elite masters rich with cash and able to create jobs – are only making deficit matters worse for political gain – and intentionally so.

In structural deficits, the deficit occurs because either tax revenue is too low or government spending is too high. In order to balance this deficit, one or both of these factors must be changed.

Tax breaks should be eliminated for specific groups of people (higher-income individuals, businesses, etc) better able to shoulder the burden, along with tax incentives for those willing to engage in job creation.

How we got here:

On September 16, 2008, failures of massive financial institutions in the United States, due primarily to deregulation and corporate elitist greed and predatory practices — exposure of securities of packaged subprime loans and credit default swaps issued to insure these loans and their issuers, rapidly devolved into a global crisis resulting in a number of bank failures in Europe and sharp reductions in the value of equities (stock) and commodities worldwide. The failure of banks in Iceland resulted in a devaluation of the Icelandic Krona and threatened the government with bankruptcy. Iceland was able to secure an emergency loan from the IMF in November. In the United States, 15 banks failed in 2008, while several others were rescued through government intervention or acquisitions by other banks. On October 11, 2008, the head of the International Monetary Fund (IMF) warned that the world financial system was teetering on the “brink of systemic meltdown.”

The Republicans now disingenuously complain about the massive spending of this Administration – spending necessitated by their failed policies which led to the economic meltdown.

The practical response

What to do when a meltdown and a depression that would make the Great Depression a pleasant memory is staring you right in the face? You do what you have to do. It became incumbent upon the US government to protect the biggest American companies responsible for transportation—airliners, petrol companies, etc.—from failure through subsidies and low-interest loans. These companies, among others, are deemed “too big to fail” because their goods and services are considered by the government to be constant universal necessities in maintaining the nation’s welfare and often, directly, its security.

In 2008-9 the U.S. Treasury and the Federal Reserve System bailed out numerous very large banks and insurance companies, as well as General Motors and Chrysler. Congress at the urgent request of President George W. Bush passed the Troubled Asset Relief Program or “TARP”, funded at $700 billion. The banks have largely repaid the money and the net cost of TARP may eventually be in the range of $30 billion. The bailout of Fannie Mae and Freddy Mac, which insure mortgages, totals $135 billion by October 2010, and could be much higher, depending on the future of the housing and mortgage markets.

TARP also encouraged banks to resume lending again at levels seen before the crisis, both to each other and to consumers and businesses. TARP stabilized bank capital ratios, that theoretically allow them to increase lending instead of hoarding cash to cushion against future unforeseen losses from troubled assets.

Increased lending equates to “loosening” of credit, which the government hopes will restore order to the financial markets and improve investor confidence in financial institutions and the markets. As banks gained increased lending confidence, the interbank lending interest rates (the rates at which the banks lend to each other on a short term basis) should decrease, further facilitating lending.

Stabilizing the economic system still left the U.S. with a staggering recession with no easy end in sight. During economic crises and recessions, the government ought to replace a drop in private spending with an increase in public spending to save jobs and stop further economic decline. As such, the measures are nominally worth $787 billion. The Recovery Act includes federal tax incentives, expansion of unemployment benefits and other social welfare provisions, and domestic spending in education, health care, and infrastructure, including the energy sector. The Act also includes numerous non-economic recovery related items that were either part of longer-term plans (e.g. a study of the effectiveness of medical treatments) or desired by Congress (e.g. a limitation on executive compensation in federally aided banks added by Senator Dodd and Rep. Frank).

The Republicans fought recovery every step of the way:

Did the Republicans embrace this necessity created by their failed policies? No. No Republicans in the House and only three Republican Senators voted for the bill.

Cutting back and worrying with the budget deficit too soon was the same mistake FDR made.

The Republicans’ maliciously motivated refusal to raise the debt ceiling is unconstitutional under the 14th Amendment. According to the Congressional Research Service, the debt ceiling has been raised 74 times since March 1962. The ceiling was last set at $14.3 trillion in February 2010.

Economists agree: The Debt Ceiling Must be Raised:

235 world economists, including six Nobel Laureates, have sent a letter to Congress urging it to raise the federal debt limit immediately WITHOUT drastic spending cuts. They warn that not raising the debt limit and/or doing so only in exchange for drastic cuts in federal spending could push the United States and the world into a global depression.

From their letter: “Congress must raise the federal debt limit immediately and without attaching drastic and potentially dangerous reductions in federal spending. Not doing so promptly could have a substantial negative impact on economic growth at a time when the economy looks a bit shaky. It will push the United States and the world into a global depression.

The U.S. economy looks fragile at present. Economic growth has been too weak to generate sufficient new job creation. Reaching the limit on total outstanding debt could force a dramatic and sudden cut in federal spending that would destroy jobs and threaten the recovery. To remove spending from the economy at such a pivotal moment would be irresponsible.

Failure to increase the debt limit sufficiently to accommodate existing U.S. laws and obligations also could undermine trust in the full faith and credit of the United States government, with potentially grave long-term consequences. This loss of trust could translate into higher interest rates not only for the federal government, but also for U.S. businesses and consumers, causing all to pay higher prices for credit. Economic growth and jobs would suffer as a result.”

The results likely will be catastrophic.

Many of the world’s largest banks, which are still hardly on solid footing after the 2008 financial crisis, would go bankrupt due to their exposure to the United States. Credit for simple things like houses and car loans may become unavailable as a result. Most large companies use short-term credit to make their payrolls. That credit would disappear, and as a result, many workers would have to start going without a paycheck. There is a very real possibility that people would go to their local bank or ATM and not be able to withdraw cash from their account. Hyperinflation could very likely ensue as the United States dollar becomes basically worthless. The “full faith and credit” of the United States is the only thing holding up the value of the dollar, so when that credit is gone, it is hard to imagine the dollar’s surviving with it.

In response to the crisis, businesses would once more lay off workers, only worsening matters and creating a downward economic cycle, which results in a depression. The stock market would plummet as well, negatively affecting the 401(k) accounts of millions of Americans.

It is this kind of scenario which led former White House adviser Austan Goolsbee to declare the mere talk of default “insanity.” As Goolsbee put it, the United States is not in real danger of default. While in the long-term, the federal debt certainly does pose a problem, currently the United States can still easily meet its debt obligations. If the United States goes into default, it will not be because of the economics, but because of the stupid, insane Republican politics behind the issue.

The consequences of that political game could have dramatic effects on the United States’ economy for decades to come.

(Citations omitted; Compiled from numerous sources)

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