Real Clear Markets

Forget the Fiscal Cliff; Focus on the Debt Ceiling

For all the talk about the fiscal cliff, it is not the most worrisome economic issue facing the country. The real cliff is the debt ceiling and if we go off that cliff, it will be catastrophic. Most people remember the debt crisis of August 2011 as hair-raising. This horror movie is about to be released again with even scarier features. Unless the debt ceiling is increased during the lame duck session of Congress, get ready for a terrifying show.

According to the Bipartisan Policy Center, the Treasury will meet the statutory limit on the debt in the last week of December. To prevent default, the Treasury can then employ certain “extraordinary measures” to free up cash to pay everything from interest on the debt to Social Security checks.  Those measures are likely to be exhausted by February 2013, according to the Center. At that point, the government can no longer pay its bills. The costs of a temporary delay are estimated at about $20 billion over the next decade – a price tag similar to what it would cost to keep Medicare physician payments at current levels (the so-called “doc fix”). Taxpayers should be irate about having to fund these special measures just because Congress can’t do its job.  

The debt ceiling crisis puts the fiscal cliff in a new perspective. Imagine that current negotiations are successfully concluded with a compromise that involves some spending cuts and some tax increases. As if that kind of compromise weren’t difficult enough, without an agreement to raise the debt ceiling such a compromise would be almost useless. Both sides would be back at the negotiating table in a matter of weeks over a much bigger threat to the economy – the inability of the federal government to pay its bills. The consequences would be a probable downgrading of our debt, a plunge in the stock market, higher interest rates, and a new and probably unprecedented financial crisis.  

This scenario makes it essential to raise the debt ceiling now as part of any compromise on taxes and spending and to take it off the table for the future as a way for one party to hold the other hostage to its views.  

The President has suggested borrowing from an idea initially proposed by Senate Majority Leader, Mitch McConnell. It would permit the President to propose an increase in the ceiling which would then go into effect unless Congress not only disapproved the proposal, but was also able to overturn a Presidential veto of their action to disapprove. Since overturning the President’s veto would take a two thirds majority, his proposal would almost always become law. Convoluted? Yes, but designed to protect members of Congress from having to be on record as having supported an increase in the debt and far better than the status quo.

Market participants should stay focused on this aspect of the negotiations. Whatever happens to taxes and spending, it pales in comparison to whether the two parties can agree to not use the full faith and credit of the federal government as a tool to extract concessions from one another. The U.S. has never defaulted on its debt (although it came close during the War of 1812 when only a private syndicate was able to raise the necessary cash to pay for mounting expenses).  

Those who believe that a refusal to raise the debt ceiling will somehow put limits on spending and shrink the size of government are confusing the need to pay obligations already incurred by Congress with the need to rein in future expenses. Spending restraint is needed and along with new revenues is the right way to fix rising levels of debt. The debt ceiling itself is an anachronism. As Alan Greenspan once put it, we don’t need both suspenders and belts.