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Debt Ceiling, U.S. Default, and What’s Next

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Debt CeilingIf you are at all interested in finances, chances are that you are aware of the current debate surrounding the debt ceiling, and the possibility of a default on U.S. sovereign debt obligations. Right now, there is a great deal of wrangling going on, accompanied by partisan grandstanding on all sides. But what does it mean? What is likely to happen if the U.S. defaults? And would it really matter to you?

The U.S. Debt Ceiling

First of all, you need to understand about the U.S. debt ceiling. Article I, Section 8 of the Constitution gives Congress the authority and responsibility to pass laws governing new debt issued by the federal government. Earlier this century, Congress decided that rather than pass a law each time, they’d institute a debt ceiling to help streamline the process. Now, in order to borrow more, a law has to be passed to raise the debt ceiling, rather than on each new debt issuance. In theory, the debt ceiling is supposed to keep spending in check so that it doesn’t exceed revenues by too much, thus maintaining the balance of power. In practice, Congress has raised the debt ceiling as a matter of course for years — no matter which party is “in charge.”

This time, though, it’s different. Some are balking at the idea of enabling the government to borrow money. When the debt ceiling was reached a couple of months ago, some politicians began insisting that they wouldn’t automatically agree to another increase in the debt ceiling. Any law to raise the debt ceiling would have to come with changes to the way the government pays for things. The debate now is over which programs to cut, and by how much. With some noise in there about raising taxes on people and corporations making more than a certain amount of money in order to raise needed revenue.

Could the U.S. Begin Defaulting on Its Debt?

If the debt ceiling isn’t raised by Aug. 2 (earlier since the legislation has to be drafted, reviewed, passed, reconciled, and subsequently signed), according to Treasury Secretary Timothy Geithner, the U.S. begins defaulting on some of its obligations. There are Social Security checks that need to go out. Government employees need to be paid. We have other obligations, such as paying interest on Treasury bonds. While everything wouldn’t be defaulted on all at once, certain obligations would need to be met.

In an interview with CBS Moneywatch, Jay Powell, a visiting scholar at the Bipartisan Policy Center, estimated that the U.S. could default on 44% of its obligations in the month of August. He says that interest would be paid (most countries don’t just declare bankruptcy and walk away from their debts), and then priorities to keep certain programs, like Defense, going would be set. But there would likely be some disruption.

And, of course, there would be disruption in the financial markets with a U.S. debt default. Stock portfolios (your retirement account, perhaps) would sink as the market crashed. Reluctance to invest in Treasury bonds would result in higher yields to try and entice foreign investors. That, in turn, would mean higher mortgage rates, and higher loan rates for businesses. A credit market crunch would be likely, and that could hurt business cash flow, resulting in lay offs.

Will the U.S. Reform It’s Financial Practices?

One thing this crisis has done is to wake many up to the unsustainable financial practices that the U.S. has been following. How to get the country back on the right financial track is a matter of debate. Some think that the problems can be resolved with tax increases, or with spending cuts. Few politicians suggest that we will need both spending cuts and tax increases to get out of this problem. (I, personally, believe that program cuts and a tax hike will be necessary.)

The real question, of course, is whether the American people are willing to sacrifice to get out of this mess. And whether we have an political leaders with the courage to do something unpopular. What do you think? What should we, as a country, do about the debt ceiling, and about fixing our country’s financial woes?

(Photo: MyEyeSees)

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32 Responses to “Debt Ceiling, U.S. Default, and What’s Next”

  1. STRONGside says:

    I know that it is much more complicated that simply to say”cut the wasteful spending”, but the bottom line of personal finance “spend less than you earn” seems to not apply to the federal government. Raising the debt ceiling will only reinforce the practice of borrowing more than our country earns, and we will continue to spiral into further debt. I actually attend church with Se. Jim Demint, and him and I have spoken several time regarding this issue. he is an adamant supporter of not raising the debt ceiling, and I for on, and strongly behind him!

  2. Ash says:

    Thank you for the balanced outline. I’ve shared it with several people that were confused about the issue.

  3. Aaron says:

    I agree that the government ought to be “living within its means” (or at least a lot closer to them) but we cannot get things in balance in the next half month such that we could pay our obligations without raising the debt ceiling. We shouldn’t have to totally dork up our economy so someone can make a point.

    By the way, Miranda, you write that “Few politicians suggest that we will need both spending cuts and tax increases to get out of this problem.” My reading of the situation is one party is suggesting exactly that–a mix of cuts and tax increases. Another party is the ones who have no interest in that. We spent the past 10 years paying for a whole lot that we didn’t have the money for, and now there’s reluctance to cover it?

  4. Prediction: The US will not default on any of its debts and will not miss any social security payments if a deal is not reached by August 2nd. In spite of the fear mongering, there is sufficient revenue coming in to continue these payments.

    • Daniel says:

      Perhaps there will be sufficient money to make debt payments and cover Social Security and active military. But there are many other services that would not be covered. If the rest of the federal employees are not paid, the economy goes from bad to worse. And the services they’re providing (VA hospitals? road repairs? food safety inspections? border control?) are halted.

      Hmm, there’s a question. If there’s no border control, is nobody allowed into the country, or can everyone just walk in?

      I think Congress should have stopped receiving funding for their offices (particularly salaries for our Representatives and Senators) back in May when Treasury first started having to prioritize.

      • tbork84 says:

        I think it would be interesting in a deeply cynical way to see which offices are deemed to be critical and which aren’t. In Minnesota, they have had the government shut down since the start of July, and they kept the regulatory enforcement office open but closed down the permit office. Nothing says efficiency like being fined for permits that you can’t obtain from a closed government office.

  5. Bob says:

    Don’t be fooled by the proposed spending cuts. The rumor right now is the Democrat proposal is heavily back loaded on a 10 year plan. There would only be a 2 billion cut the next fiscal year with most of the hypothetical cuts occurring in years 8, 9, and 10. The end game has to be a balanced budget and no national debt, no matter what party your for. A hard correction now would be much easier to handle than possible austerity measures in the future.

    • NateUVM says:

      Agreed. Tax increases then. Real tax rates right now are the lowest that they’ve been in decades. It’s no wonder we find ourselves in an unsustainable fiscal situation.

      On the demand side, it’s not like we’ve been adding services or fully funding the ones we already have. Quite the opposite, rather.

      Want more employement/innovation? Fund more/better education. That costs money. The only problem is that the payoff is after the next election cycle.

      • Texas Wahoo says:

        “On the demand side, it’s not like we’ve been adding services or fully funding the ones we already have. Quite the opposite, rather.”

        Do you really think we haven’t been adding services? The area around Washington, DC is booming right now, and it’s not because of the great weather… What do you think all of those people are doing?

        • daenyll says:

          Just because there’s added bureaucrats doesn’t mean any value has been added in the way of service to the public. Just like added regulations or rules doesn’t mean anything is actually being enforced.

          • Texas Wahoo says:

            Then maybe we should cut the number of bureaucrats, while leaving the number of services the same?

  6. freeby50 says:

    I agree with Biz of Life. There will be no default. I also think that there will be an agreement to extend the debt limit. It may come at the last minute and be nothing more than a bandaid fix, but I expect there will be some agreement. Right now both parties are playing politics with it. But nobody wants default and they won’t let that happen. Even if we have to sell Florida.

    • Daniel says:

      I think you’re right. Something will happen at the last minute, and it will be a bandaid fix. And the unproductive rhetoric will continue until the 2012 election.

      Selling Florida may not be such a bad idea. Although perhaps we could retain ownership by making a multi-year lease agreement. Maybe provide mining rights to China, with the annual cost dependent on how many regulations they must adhere to. Offering complete environmental destruction of Montana might pay off a big chunk of our debts.

  7. DIY Investor says:

    The problem is that we are in unchartered territory. Almost 50% of our national debt is owned by other countries. They don’t want to buy our goods so they buy our financial assets. This is how we have been living beyond our means for so many years.
    If we reach a tipping point and they get scared they could dump U.S. Treasuries wholesale causing interest rates to skyrocket. It could get very ugly.
    The same politicians that are ranting and railing are the same ones that pushed through spending bills and huge tax cuts. I for one am voting wholesale against incumbents. They need to get a message.

    • saladdin says:

      Please educate yourself before posting such things.

    • NateUVM says:

      So, let me get this straight… China, say, decides to dump it’s U.S. debt… So, not only do interest rates go up, lowering the value of the Treasuries they are trying to sell, but because there are so many more of them being sold, the price falls even further.

      Again, China wants to LOWER the value of this asset they hold? Why again?

      Now apply that to anyone who holds US debt. Why would they want to divest?

      • Vic says:

        Think of it as insurance. US gets any ideas of meddling with China’s core policies, BOOM sell the treasures, the dollar plummets and US can’t fund it’s plans to flex any military/financial muscle.

        Would it hurt China? Sure. But their citizens have a savings rate of 20-40% versus the US were until the financial crisis a net NEGATIVE rate (4-6% right now) so they can take the blow where the US could not.

        The “shot heard around the world” could be someday the “the trade seen around the world”. Remember the Brazilian president talking about ‘currency wars’? It’s a possibility. I honestly don’t think it would ever happen but the scenario is there.

      • Texas Wahoo says:

        Who said china wants to lower the value of the assets they hold? They would be trying to sell out of the asset – which could have the effect of lowering the value of the asset they hold.

  8. saladdin says:

    I promise myself each time I see these posts I won’t read them but I always do.
    There is always so much uneducated simplicity used when people comment on such a complex topic it makes me want to kick puppies.

  9. skylog says:

    to me, this is simply a manufactured debate. are there complex issues at play? yes? does the united states need to do many things to get itself in financial order? yes. does the debt ceiling really have that much to do with getting there? not really.

    i do not, repeat, do not want to turn this into a political discussion, but i am having trouble understanding why the right suddenly takes issue with raising the ceiling. it was raised in 7 of the 8 years the latter bush was in office.

    this will get passed, after far too much debate, press, concern, worry and such. both sides will keep playing the press and “give up” things they both want…and little will come of it. instead of actually DOING SOMETHING about the financial problems in this country, again, time will be wasted with “politics.”

  10. Yes I Am Cheap says:

    It’s always important to pay off the debt when the time comes. Defaulting on payment makes up a bad image.

  11. Diane says:

    Last minute resolution frankly will not be good enough. Moody’s is about to downgrade us now (probably over the next week), based on this nonsense. Even if it get resolved, there will be impact from this.

    “The Economist” does not understand how a country like the US can let this political Kabuki theatre actually derail serious financial obligations. It’s childish games that are going to have heavy consequences.

    • NateUVM says:

      Anyone who saw the results of the last mid-terms should be able to understand how childish and short-sighted we all can be in this country.

  12. arif says:

    Stop all wars and live peacefully. Learn from President Clinton. He had respectable surplus budget and no wars. Then Bush put the bush on fire by starting mutiple wars. That has put us on the downhill path. We do not want to go USSR way.

  13. arif says:

    The comments fail to address real cause of soaring debt. The stupid wars!!! Please pay attention or it may be too late. Learn from USSR demise.

    • NateUVM says:

      While the wars hurt, and certainly place us at a higher level of debt relative to GDP, those actually aren’t the main drivers of the unsustainable condition we find ourselves in. Eliminating them would help, but…there was a recent study that found that if we merely went back on ONE “recent” change, while we would still be at a higher level of debt/GDP than we were at before, we would at least be back to a sustainable situation. That ONE thing…?

      The Bush tax cuts.

      Now, take that with a grain of salt…I can’t seem to find the link anymore (who’s heard THAT one before?!), but even if it’s not the case, it should at least be food for thought that there is another way, in addition to cutting the fat, that should be considered. Again, in real dollars, we’re currently paying the lowest tax rate in decades. How is that at all sustainable considering the challenges we face?

  14. Jamie says:

    I doubt that US will default on it’s debts, at least not yet. I think it is going to be like with TARP in 2008. Politicians talk and talked and after second try they reached the deal. I think that similar scenario will happen this time again, i just hope that this time markets will not be in free fall.

  15. pat says:

    I guess even though I was born in Indiana and have lived in the US all my life, I’m not an American because quite frankly, I think we’ve made quite enough sacrifices. I’ve watched my local school district go downhill. I have to deal with a lot of roads and public buildings in disrepair. I used up my retirement savings during the Reagan years because I couldn’t find a job after being laid off from a public sector job I’d held for 14 years. Now, I can’t afford a refrigerator or new stove or make major repairs to my home. My car is 20 years old. And with the exception of being out of work for three years under Reagan I have worked all my life. I do pay cash for everything – I don’t have a credit rating because I don’t use credit. But how on earth can someone who makes over $250,000 a year suggest I need to make further sacrifices?The corporations and wealthy have milked us dry. The money is no longer there.

  16. jake says:

    I find it interesting that the Government wants to go further into debt. It is never wise to spend more than you take in. Sooner or later someone has to pay the piper. It is only prudent that some spending cuts be made but not at the expense of promised benifits to retirees IE: Social Security and Medicare. There are more than enough spending cuts to be made in other areas, useless wars and overseas military bases and operations come to mind quickly.
    As for a fair tax system, how about a flat rate tax on everyone, businesses and corporations too. This would be the only fair way to do it, everyone pays the same rate, what a concept!!
    It always takes a balanced approach to spending your income wisely. Prioritys will have to change. You can’t have it all MR. Obama and Mr. Boenner.

  17. selene says:

    it really is absurd to know that a powerful country like U.s has been experiencing a clumping crisis like this. but this appears to be a wake up call that as u.s has been exposed in this recession, the other countries are as presented to the same notion. we should all keep our hands tightly closed……


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