Democrats and Republicans in Congress, not to mention the President, are battling over what to do about the debt ceiling, an arbitrary limit of government borrowing set by Congress. The government borrows money from investors in order to pay its expenses, like salaries and Social Security, and if the government is unable to borrow, eventually money will run out. That’s a consequence of spending more than you earn, a basic personal finance concept that doesn’t translate well to building what was one point, though still may be, the most powerful national or sovereign economy in the world.
The government has approached the debt ceiling before, and every time, Congress has acted to raise the debt ceiling. Today, politicians are more divided than ever, and it’s looking like a firm deal is not going to happen right away. The most likely outcome is that Congress will delay the issue with a temporary extension of the debt ceiling, moving any action to the future — and closer to the next presidential election when more citizens are ready to engage in political fights. There’s a very slim possibility that the stale mate will continue past August 2, which is when, according to the Treasury Department, the obligations require more than the government has, and some tough choices will need to be made.
If this does happen, President Obama will need to make some tough decisions about who does not get paid. The most likely option will be to furlough parts of the federal government, so military salaries and Social Security payments would not be interrupted.
Rating agencies like Standard & Poor’s will likely downgrade the official AAA rating for the United States’s debt. Even if a temporary solution raises the debt ceiling, this is still a possibility. Many investors would not lend money to the government if its credit rating slips, and interest rates may rise to compensate willing investors for the perceived risk in the system. These interest rates could affect everything from mortgage interest rates to credit cards, making the cost of borrowing higher throughout the economy. However, Japan’s rating was lowered in 2002, and the country suffered no ill effects, so it remains to be seen if rating agencies’ opinions matter as much as people believe. Even S&P has indicated the effects of a downgrade would be minimal.
I think the BBC, whose audience may not be familiar with the intricacies of the U.S. Constitution, sums up the situation interestingly:
Why can’t the Obama administration borrow more? Because it is not in their power. All government borrowing has to be approved, under the US Constitution, by Congress… Perversely, Congress also sets the government’s spending commitments and tax-raising powers. This puts the Obama administration in the impossible position of being required to spend more than it earns, while also being prevented from borrowing the difference.
Another possible consequence is the further reduction of the value of a U.S. dollar compared to other currencies around the world. The dollar’s value has been falling for years, so it may difficult to say if a continued fall is the result of a government default, but it certainly can’t help. If the dollar continues to fall, the typical reaction would be to put money into hard assets like real property.
Over the past few years, people and businesses who could qualify as borrowers have had the benefit of very low interest rates. If interest rates do increase, it would come at a bad time. The country is still trying to claw its way out of a recession, and high interest rates are bad for businesses trying to expand. The good news is only some businesses are trying to expand; most are saving their cash as is evidenced by the reluctance to hire more than the bare minimum of employees.
If the consequences of a ratings downgrade are not as dire as the media portrays, as opined by experts, the issue shouldn’t really be receiving all the attention it has. It does bring to light the issue of spending more than the government can afford, but it’s more of a political issue than an economic issue. Means that our representatives are using the debate on the debt ceiling to distract from the bigger economic problems we are facing, like unemployment, a lack of business growth, a substandard education system, endless spending on wars, and ineffective regulation of the financial industry.
Updated August 3, 2011 and originally published July 27, 2011.