This week was of high political voltage because of the debt ceiling debate. Could the most important economy in the world default its debt? And in such case, what would happen, not only to the United States, but to the worldwide economy, given that we are in the midst of a financial crisis? The recent agreement, it is said, seems to offer a kind of solution (better or worst) to the debt problem. But a few details need a closer look to understand to what extent the agreement was actually a solution.
The signed bill increases the debt ceiling by $2.4 trillion over one year and half. By the end of 2012 the total debt will increase from $14.3 trillion to $16.7 trillion. This is represents 16% increase in the total debt. There are also other $2.4 trillion. But this $2.4 trillion is a reduction in how much the increase in government spending will be reduced in the next ten years. In other words, the $2.4 trillion do not represent a spending reduction from previous year, it will just grow $2.4 trillion less. Because government spending will still grow, total debt will still grow. As Richard Ebeling points out, the Treasury receives permission to borrow and spend $2.4 trillion in the next year and half, but government will “save” $240 per year. To match the remaining amount, the government should spend $20 billion less every month for the next 10 years.
Can this be the solution? All this stress and discussion for such a simple agreement? The main problem is that the deficit problem is not solved, it just has been postponed. There are only two ways to pay to creditors. Increase revenue or reduce outlays. The former requires an increase in taxes, the later to decide which areas of government activities should see their budgets cut. But there’s another important aspect of the agreement, the date when a new round of negotiations should take place to decide where the projected spending should be reduced. Will this take place before or after the presidential elections next year?
The hard decision, to cut spending or increase taxes, still have to be made. So far, a pass to avoid short term problem was agreed. It should be noted, however, that a default occurs when the state does not pay its debts, not when it hits the debt limit. If the Congress and the President can sign a bill to extend the debt ceiling and affect the projected government spending, why can’t they sign a bill reducing spending to face the debt payment and avoid a default or a temporary payment suspension? The debate was presented on terms of default or not to default, while the problem actually had a third alternative, reduce spending to avoid default. Isn’t that what households and firms actually do when they face a similar problem?
This agreement may have avoided short term stress, but it drags a dangerous precedent that doesn’t seem to be discussed enough, which is the modification of the debt ceiling. A norm like a debt ceiling is useful not when one is far from it, but on the contrary, when it’s binding. What’s the point of relaxing the debt ceiling at the specific time when is important? If that’s the political behavior, then the debt ceiling is not a limit to government debt and size, but a political tool of bargaining; as actually seems to have been the case. It ceases to perform the institutional role for what is was designed to become a political asset for negotiations.
The question the next president will have to face is not what is the best way to reduce the level of government spending, but what course will the United States take on the long run. Will it reduce fiscal deficit and reduce the debt weight, or will, again, increase the debt ceiling and move closer to a european-kind of social-welfare country? The next presidential elections will be about the United States becoming a European country or going back to civil liberties and limited government. Where is the United States going to be 10, 20, 50 years from now will depend on what path is taken.
Nicolas Cachanosky is a doctoral student in economics at Suffolk University, as well as a previous Sound Money Essay Contest winner.