Debt Ceiling Talks Reignite

Written By Briton Ryle

Posted May 10, 2013

What’s that shiny metallic object just ahead on the road? Is it… Yes, it is! It’s the can they kicked at the end of last year – the “debt-ceiling can”. Contrary to politicians’ beliefs, kicking things doesn’t make them go away after all.

congress capitol hillThe United States had officially reached its debt ceiling on December 31st of last year. But being unable to deal with it then, the U.S. Congress suspended the borrowing cap until May 18th by passing the ‘No Budget, No Pay Act’ early this year. It was a little prod to get a budget passed, essentially stating, “We won’t deal with the debt ceiling until we’ve dealt with the budget first.”

Well, the budget has yet to be dealt with, with 3 versions making the rounds – a Republican House version, a Democratic Senate version, and President Obama’s.

So here we are again. May 18th is fast approaching, and nostrils are flaring over the next round of debt ceiling debates. Republicans want the government to cut spending and lower taxes, and they have sworn not to approve any credit limit increase unless the government makes those concessions. Democrats contend that cutting spending now will derail the economic recovery.

Well, the Republicans have a little card up their sleeve; a bill passed in the House of Representatives yesterday which they believe will force the Democrats to see it their way. Yet all this is doing is diverting the debate away from the real issue at hand: the looming credit limit.

It looks like the limit will have to be dealt with the old fashioned way… by giving it another kick.

Sneaking One Through

The last time they encountered the debt ceiling can, the parties came up with a clever way of approving a limit increase without actually having to vote on it.

At the end of January, Congress voted to suspend the country’s debt limit until May 18th, giving the government permission to continue borrowing and spending as usual. When that credit cap is restored on May 19th, the limit will be increased by the amount borrowed from January 1st to May 18th – automatically, no voting required. In so doing, Congress snuck a credit limit increase past the security guard, and it seems prepared to do yet again.

The Treasury Department is ready and able to transfer funds between government accounts to continue maintaining its spending obligations, such as debt and interest payments to governments abroad, and social benefits and government employee wages at home.

Some estimate the government is fully prepared to honor such obligations for several months beyond the May 18th credit limit deadline to as late as September.

“Based on the way the debt ceiling and a lot of other financial issues have been handled over the course of the last four to five years, probably it’s inevitable we get to that point,” Representative Frank Lucas (R) predicted in a Bloomberg interview.

With that, another deadline coming will likely mean another deadline going. Temporary fixes keep getting revisited, only to be met with yet another temporary measure designed to buy more time. Oh, that poor tin can.

Don’t Trip The Alarm

It seems so certain that the credit limit talks will fail that the parties are already fighting over its aftermath – how to decide who to pay and who not to pay after failing to secure a debt ceiling increase.

Failing to secure a credit increase means failing to pay someone. If they fail to pay the wrong obligations, they run the risk of having credit rating agencies blow the whistle and downgrade the nation’s credit rating, resulting in higher interest rates when borrowing from foreign governments.

And thus we have that bill mentioned at the outset, which the Republican-controlled House of Representatives passed yesterday outlining its list of debtors who should be paid first should debt ceiling negotiations fail.

“Our goal here is to not default on our debt,” House Speaker John Boehner (R) stressed to Bloomberg. “Our goal here is to get ourselves on a sustainable path from a fiscal standpoint. Doing a debt prioritization bill makes it clear to our bondholders that we’re going to meet our obligation.”

To ensure the U.S. does not default on its obligations, the Republican House bill would reclassify which payments fall under a credit limit and which payments are considered “exempt”, or “limitless”. By moving a number of payments outside the credit limit, the government would be able to continue borrowing at infinitum to pay those obligations. But any payments left under a credit limit would simply stop being paid until a limit increase is fully approved.

The reasoning behind this, Ways and Means Committee Chairman Dave Camp (R) explains, is that the two largest credit-rating agencies – Moody’s and Standard & Poor’s – have indicated that while they see the failure to make a debt payment as credit rating-sensitive, they do not deem the failure to make any other type of payment (such as wages to government workers and social benefits) as a measure of default.

Separating payments into two groups in this way – “limitless debt-related essentials” from “limited non-essentials” – would allow certain payments to be skipped while avoiding defaults and credit-rating downgrades.

Yet this “Debt-Prioritization Bill” makes demands that will likely never be approved by the Democratic-controlled Senate. “I call it the ‘pay-China-first’ bill, because what it really means is we’ll pay China before we’ll pay veterans, before we’ll pay seniors, before we’ll pay contractors,” Representative Steny Hoyer (D) voiced his irritation.

Representative Kevin Brady (R) countered, “The Senate would be opting for another showdown, another unnecessary round of uncertainty if they weren’t to take this bill up.” “It makes sense to do this, unless, you want to flirt with default, which we don’t,” he defended.

But Democratic members of the Ways and Means Committee dissented in their report on the Republican bill. “The Democratic Members of the Committee strongly oppose this legislation, which is simply a plan to default on the full faith and credit of the United States,” they condemned. To them, any missed payment – whether classified credit-rating sensitive or not – is still a default on the government’s obligations to its own citizens.

The Inevitable

As long as the can is still laying on the road, the risk of default and credit-rating downgrades will always be there. Given the demands each side is making, it is unlikely the United States’ debt ceiling issue will be resolved by the time the limit is reached on May 18th.

Of course, the world’s most powerful economy will not explode on the day after reaching the limit. Governments are pretty clever at finding money somewhere whenever they need it. But don’t expect that tin can to be picked up off the ground and tossed into the recycling heap any time soon.

What we can expect, however, is that the pinging and clanking of that can as it keeps getting kicked further along has before and will again attract the attention of credit rating agencies around the world.

Do we all remember when the United States’ credit rating was downgraded last? August 5th, 2011, marked by black arrows on the chart below. And do we remember what happened as a result? The Dow Jones Industrial Average dropped some 9% in one week, while gold rose almost 15% in three weeks to hit its all-time high.

gold dow chart 5-10Source:

Joseph Cafariello


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