Understanding the Default Debate

Monday, 01 Aug 2011 03:20 PM

By Herbert London

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“Default” is a word used so often in the last two weeks that it engenders fear and trembling across the nation.

Presumably default would mean the U.S. credit rating would be downgraded resulting in higher prices, increased interest rates, and a belief America is in decline. The fact that the bond markets have remained stable in the face of this potential volatility suggests a very different reality.

Tax receipts of $2.2 trillion are more than enough to meet financial obligations from Social Security checks to military expenses should default be in the cards.

However, now that a deal between the House Republicans and the Senate Democrats has been constructed, default has been averted. But since very little has been agreed on besides increasing the debt limit, the spending and retrenchment issues lie basically untouched.

The can has been kicked down the road to be addressed another day.

The real issue can be stated with one number: 14 trillion, the accumulated debt. The secondary number is 2.5 trillion, the annual deficit.

In order to understand what is at stake here, the nation’s GDP — that is all the goods, services, and assets in a given year — is roughly equivalent to the debt. Forty-three cents of every dollar government spends is borrowed. Assuming continued borrowing comparable to what we have recently experienced, financing the debt in 2020 will be about the present magnitude of the defense expenditures. What this adds up to is a government living beyond its means.

If there is a single tea party message, it is to simply stop spending at this outrageous pace because it is generating national insolvency. The spending binge of the Obama administration has been unprecedented. Although the president insists this spending was needed to prime the pump of economic activity, the net effect has been disappointing.

The argument employed during the debate on the $850 billion stimulus bill, for example, is that it would lower the unemployment rate which was then at 7.3 percent. Instead the unemployment rate has risen to 9.3 percent, a fact that has members of the administration scrambling for an explanation — with one member of the term arguing that “the unemployment rate doesn’t matter.”

Moreover, the president appears to be MIA, missing in action. Despite claims that the Republicans cannot accept “yes” for an answer and that he is the great compromiser, the Republicans have submitted and passed two proposals in the House and the president has yet to define his own position.

Not one plan has emerged from the White House. Even partisan Democratic leaders have, behind closed doors, described this absence as a vacuum in leadership.

On several matters there is emerging consensus. New taxes will not be considered. Some spending cuts — with various levels debated — will be put in place and, of course, the debt ceiling will be raised. But it is essential to restore fiscal sanity and address long-term spending without breaking the bank.

It should be understood that the debt level is not sustainable. If the U.S. wants to avoid the European sickness of debt strangulation that Greece is now experiencing, it must bring its fiscal appetite under control.

The real lesson in these Washington deliberations is that debt is deadly. It can prompt decisions that not only destroy a lot of wealth, but force a declinist scenario from which the county may not easily recover.

Consider, for example, an effort to monetize the debt, a natural temptation considering the magnitude of the problem and the many Americans seduced by entitlements. This strategy would usher in an inflationary tsunami. The U.S. may not resemble Weimar 1921-22, but it could certainly wipe out much of the nation’s asset base.

Talking heads on TV and elsewhere contend either doomsday is here or the entire crisis has been fabricated for political advantage. Depending on your perspective, a case can be made for either scenario.

But on one matter conjecture is not necessary: spending on the order of what the nation has experienced in the last three years is not acceptable. Retrenchment has to begin sometime and many Republicans and a few Democrats contend that time is now.

Herbert London is president emeritus of Hudson Institute and author of the book Decline and Revival in Higher Education (Transaction Publishers).









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