(April 21, 2011) Rather than saving the economy, raising the US debt ceiling would further undermine the US dollar’s standing as the world’s reserve currency.
The United States may soon do something “unthinkable [that] must be avoided,” something that “could lead to the loss of millions of American jobs,” something “deeply irresponsible” that would trigger “catastrophic economic consequences that would last for decades.”
These warnings and others are packed into a remarkable 1,500-word letter from U.S. Treasury Secretary Timothy Geithner to all 535 members of the U.S. Congress, spelling out in detail why a failure by Congress to raise the U.S. debt ceiling would “compromise America’s creditworthiness in the eyes of the world,” undermine “the dollar’s dominant role in the international financial system” and “raise all borrowing costs,” leading to the “loss of the nation’s triple-A credit rating, sky-high interest rates and rapid inflation, all of which would make a return to prosperity, job growth, and balanced budgets an impossibility.”
Geithner’s pull-out-all-the stops letter is remarkable because, on almost every count, he has it exactly backwards. It is the prospect of a higher debt ceiling and thus higher U.S. borrowing that led Standard & Poor’s this week to give the U.S. government a negative outlook for the first time in history — tellingly, S&P did not once express angst over the existing debt ceiling.
It is the level of U.S. borrowing that undermines the dollar’s standing as the world’s reserve currency and raises the prospect of rapid inflation — in the United States, as well as around the world. As The Wall Street Journal reported this week, with the debasement of the dollar continuing unabated, “the world is starting to protect, and perhaps ultimately free, itself from America’s weak dollar standard. The European Central Bank recently raised interest rates and may do so again to prevent an inflation breakout…. At a meeting of developing countries — the so-called BRICs — in China recently, leaders called for ‘a broad-based international reserve currency system providing stability and certainty.’ They weren’t referring to the dollar.”
Unlike most other major Western economies, the U.S. economy is experiencing unusually high unemployment coupled with unusually low growth in GDP. Forecasters at firms such as Morgan Stanley and RBS Securities have been revising their U.S. GDP estimates downward, and Capital Economics this week painted an especially grim picture, speculating that its forecast of a paltry 1% GDP growth may actually be optimistic: “there is now even a decent outside chance that the economy contracted outright,” it advised its clients.
If Geithner’s worst fear came to pass and the U.S. Congress refused to raise the debt ceiling, his litany of horrors would evaporate. With the U.S. government unable to borrow willy-nilly, the Federal Reserve would not print the dollars that now spur the government’s stimulus spending spree. The lenders who hold $9-trillion in marketable U.S. debt would immediately see its value appreciate, quelling their fear of being repaid in grossly inflated dollars and eliminating any need to abandon U.S. bonds, as some fear may have begun with China’s unloading in January and February of $6-billion in U.S. bonds. With the U.S. dollar solidifying, talk of switching to a new world currency would vanish. U.S. borrowing costs would decline. And Standard & Poor’s would reverse its negative outlook, no longer concerned, as it is, that the U.S. has “very large budget deficits and rising government indebtedness [without a clear] path to addressing these.”
How could Geithner have things so wrong? His list-of-horrors-letter equates a failure to raise the debt ceiling with a default on the U.S. debt. They are entirely different matters. Should Congress refuse to give the Obama administration more money to spend, the government would continue to service its bondholders — foreign and domestic — with ease. The government’s net interest payments on the debt this year are projected to be $225-billion, a mere 10% of the $2.2-trillion in taxes and other receipts that it will be bringing in.
The real “catastrophic” consequences would not involve the dollar but the Democratic Party’s prospects for re-election. Geithner’s letter contained a second list, of the many political constituencies who do business with the government, or who have a perceived entitlement to the remaining 90% of federal receipts. The list is lengthy, including the states expecting block grants, students expecting loans, Medicaid recipients, and the civil servants whose paycheques come from the federal government. Because the remaining 90% isn’t enough to keep all the recipients of federal largesse in the style to which they’ve been accustomed, and because many others with hopes of joining the largesse list would also have their sails trimmed, the Democrats would face discontented constituents who could take it out on them at election time.
Issuing pink slips for federal employees, and cutting back entitlements, is never a pleasant task, even without political survival at stake. But it is a necessary task. Postponing the day of reckoning would at best make the ultimate adjustments harder to weather. At worst they run the risk of a true default, and a true catastrophe, should another severe recession, oil crisis or other shock to the economic system hit.
That very live risk makes raising the debt ceiling a course of action that truly is “deeply irresponsible.”
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