Default 'Catastrophe' Explains Why the Debt Ceiling Shouldn't Be Increased

by John Tamny,  Toreador Research and Trading (Guest Contributor)


Treasury Secretary Tim Geithner has said that if Congress doesn't agree to a debt-ceiling increase that the federal government won't have the means to pay its bills, and that such a scenario would deliver on us a "catastrophic economic impact." Geithner has been joined in this bit of scaremongering by Ben Bernanke, our walking, talking contrarian economic indicator who also serves as Fed Chairman.


For fun, let's assume for a moment that much as stopped clocks get the time right twice a day, that Geithner and Bernanke are for once correct. If so, their breathy warnings explain why it's essential that a Republican Congress that pays lip service to smaller government must not give in to Geithner's apocalyptic warnings.


Indeed, if "catastrophe" is the certain result of a U.S. debt default, it's fair to say that Treasury will not default. Rather than default, Treasury will be sure to pay interest due on U.S. debt, after which a spendthrift Congress will be forced to make do with funds left over. At that point a Congress that has never been required to make "tough choices" will have to do just that. Programs will shrink, or be abolished altogether, and we'll all be better off as a result.


To the above naysayers will point out that it's overly simplistic to suggest that Treasury can avoid default by simply staying current on interest due. The argument they make is that revenues flowing into Treasury are uneven, and that merely making interest payments is a dicey task given the uncertain dollar inflows. But rather than a promising argument in favor of raising the debt ceiling, this speaks once again to the importance of maintaining the one we have.


Indeed, if we face an economic catastrophe should Treasury default, it's apparent that Congress will not be allowed to make do with the dollars left over after Treasury makes its interest payments. Instead, Congress will happily be forced to leave substantial sums of money with Treasury over and above what's required to pay interest payments to make sure that it's got cash on hand should dollar inflows at any time decline. As such, Congress will have even less money to spend, thus requiring even sharper thinking from the bloated minds of the political class about where certain cuts can be made, not to mention other programs that can be abolished.


In short, the presumed default catastrophe driven by an inability to increase debt is precisely why it shouldn't be increased. If it's in fact true that a failure by Treasury to remain current on monies due would shake the global economy, it's fair to say that we'll never reach that point; the better option one of finally shrinking a federal government that has grown far too large.



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Assuming an actual default, it seems there that the Geithner, Bernanke and Congress doth protest too much. Default doubtless would shake confidence in U.S. debt, this would surely put a dent in global returns enjoyed by investors who specialize in buying it, but then it should be said that U.S. taxpayers should not be on the hook when it comes to subsidizing the world with a supposedly bulletproof place to park their capital.


Interest rates surely would go up if Treasury were to default, but then the pain of higher rates would largely be felt by a federal government that does too much, and spends too much. Higher interest rates would put Washington on a diet, and while it would lead to more difficult times in our nation's capital through reduced spending, capital not vacuumed up by Washington would be left to the productive in the private sector. Washington's recession would be the rest of the world's boom.


Some will say that a Treasury default would lead to higher interest rates for all entities public and private who access the capital markets, but if so, that's to be embraced. It's well past time that interest rates better reflect market realities, plus if rates increase, the unspoken of positive here will be an increase in capital made available by savers to entrepreneurs based on savers achieving a higher return for monies that aren't consumed.


More broadly, it's time to but to bed the silly notion that says that U.S. has never defaulted. That's truly a laugh. Indeed, it must be remembered that the dollar, rather than a commodity, is merely a concept, or a unit meant to measure real wealth. In the case of the U.S., a dollar concept that bought 1/35th of an ounce of gold as recently as 1971, now buys 1/1500th of an ounce of gold, and that substantial devaluation of the dollar concept makes plain that we've been defaulting for 40 years. About this near 40-year default by our government, it should be said that it's surely been tragic for all the great economic ideas that never materialized thanks to floating money values, but it's certainly not led to the Great Depression scenarios trotted out by our hapless leaders at the Treasury and Fed.


As for a Republican Congress that talks a great game about the importance of small government, it's been handed the political opportunity of a lifetime. Voters are overwhelmingly against an increase in the debt ceiling, which means Congress has the electorate's backing when it comes to holding the line on any increases. After that, Republican apologists always say that the GOP would cut spending but for institutional inertia which makes true reductions an impossibility.


The above never seemed credible, but whether it was or not, the voters don't want a debt-limit increase, and the failure to increase the latter would force the spending cuts that Republicans claim they want. In short, votes by any Republicans in favor of a debt-ceiling boost are votes for the kind of big government they regularly rail against. Now is our chance to see if they actually believe their own rhetoric.