United States debt limit dilemma

June 14, 2011

Pres. Obama and U.S. Treasury Secretary Timothy Geithner have warned that if Congress does not raise the national debt ceiling by Aug. 2, the government is at risk of defaulting on its debt obligations and triggering a global financial crisis.

Just how serious is this assessment? According to CU-Boulder economist Jay Kaplan, it's pretty serious.

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June 24, 2011         

Pres. Obama and U.S. Treasury Secretary Timothy Geithner have warned that if Congress does not raise the national debt ceiling by Aug. 2, the government is at risk of defaulting on its debt obligations and triggering a global financial crisis.

Just how serious is this assessment? According to CU-Boulder economist Jay Kaplan it’s pretty serious.

CUT 1 “The people that say this will be inconsequential I don’t think they have a firm grip on the economics here. The economics say it’s probably -- on a scale of one to ten of economic events -- this is a ten.  This is the biggest. The U.S. government threatening to default is just incredible.” (:20)

Kaplan says if the government does not raise the debt limit there will be a cascade of disastrous economic consequences.

CUT 2 “Any loss in the confidence in a financial asset means that its price will decrease and, of course, the U.S. Treasury debt is a financial asset.  The government is essentially defaulting, that’s a loss in confidence. Its price will fall, probably, dramatically. (:11) A fall in price means a rise in yields. Almost all other interest rates are keyed off of treasuries. For example, the 30-year mortgage rate is keyed off the 10-year treasury rate. And as most adjustable rates are all keyed off other treasuries. So if treasury yields skyrocket, which they probably will as the price plummets, that means mortgage rates will rise substantially. (:32) Auto loans, student loans, credit card rates – all keyed off, in many cases, the treasury rates.” (:37)

Kaplan says high interest rates could lead to a further decline in property values, which in turn hurts local and state government revenues. He says that also means business loans will be more expensive, which could hurt investments at a time when the economy is struggling to recover.

And while interest rates rise Kaplan says there will be a “multiplier “effect as government cuts spending to pay off the deficit.

 CUT 3 “If the government cuts spending by a dollar what we estimate the multiplier effect on the general economy is probably another $2. So if the government cuts spending we cut spending, our spending, because there are less revenues, it trickles down to fewer jobs and things like that. (14) So overall spending may be cut by $3 when it affects people who are laid off because they lose their government contracts. (:19) And who knows how the government is going to come up with that $1.5 trillion dollars initially over a year. So the first few months they’ll have to cut a few hundred billion dollars. But where does that come from? Do they cut benefits for social security recipients? So they have to cut their spending. So that means less moneys is being spent at the shopping centers and so these businesses are lying off their workers. They’re not spending and so that’s the multiplier effect. (:44)

Foreign governments and investors hold A third of U.S. debt. Kaplan says if the federal government defaults he anticipates a panic sell of treasury notes, which will further lower the value of the dollar causing imports to be more expensive.

CUT 4 “As soon as there is an idea that the U.S. government is in trouble there is probably going to be some panic selling. That will further lower the price.  And also, because these are international transactions, it will affect the value of the dollar. If they are selling U.S. financial assets the value of the dollar will fall against other major currencies. (:21) And if the dollar value falls it has two very important impacts. First of all import prices rise simply because the dollar has less purchasing power. And for every dollar we spend about a third is on imports. So that will raise the price of many goods and services that we consume.” (:40)

And Kaplan says most Americans, one way or another, have assets in government debt.

CUT 5 “U.S. government debt is held by domestic savors, foreign savors, pension funds, foreign government, banks hold quite a bit, the social security trust fund holds quite a bit. (:10) Basically, anyone in America who saves, either directly or probably indirectly, has a part of their savings in government debt. So everyone is affected.” (:20)

According to a recent Washington Post-ABC News poll while a large majority of Americans say the U.S. economy would most likely suffer serious harm if Congress fails to raise the debt limit, barely half support raising the limit even if lawmakers substantially cut spending.

Never in its history has the U.S. defaulted on its debt obligation. Something that that Kaplan says is very unique among nations.

 

-CU-

 

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