published Wednesday, October 9th, 2013

Personal Finance: Debt ceiling follies risk economic disaster

Chris Hopkins

Congress and the president haven't been able on agree on much, as evidenced by the lack of a budget resolution and the current government shutdown. This unwillingness to work together has produced torpid economic growth and diminished international stature.

But these self-inflicted wounds are merely boo-boos compared to the potential carnage that would be wrought by failure to raise the debt ceiling.

We last fought this battle in 2011. Back then, no one took seriously the threat to refuse an increase in the limit, since the consequences were so obviously catastrophic. Nevertheless, the stock market fell by nearly 15 percent in response to the unseemly consideration of such a course.

This time around, positions are hardened and what was once unthinkable can no longer be ruled out.

According to the U.S. Treasury, the drop-dead date is Oct. 17. After that, some U.S. creditors won't get paid. In credit markets, this is known as a default. In economics, it is called suicide.

Many people, including some members of Congress, mistakenly believe that our Federal debt limit is a safeguard intended to constrain the amount of debt the Government accumulates. In fact, it is an antiquated relic of America's effort to raise money to fight World War I.

Prior to that, Congress had to authorize each and every issue of government debt. With the passage of the Second Liberty Bond Act in 1917, the Treasury was authorized to sell war bonds at will up to a specified limit.

In the 1930s, an aggregate limit for all U.S. debt was instituted. Since then, legislative action has been required over 100 times to raise the ceiling as financing requirements increased.

The problem is, government borrowing is determined simply by two factors: how much Congress spends and how much it taxes. The difference (almost always more spending than revenue) is known as the deficit, and must be made up with debt. To be clear, this deficit was already stipulated when Congress and the president agreed upon the last continuing resolution.

So the spending is done, and we know what our income will be. We bought a big screen TV and put braces on the kids, but didn't earn enough to pay cash and had to charge some on the credit card. Today the bill came in the mail. The debt ceiling debate is a discussion over whether or not we will pay the Visa bill.

Guess what happens to your credit rating if you choose to renege. Same for Uncle Sam; in fact, one major agency downgraded us last time we even entertained the thought. More downgrades and a potential recession lurk around the corner this time if we blow it.

By any reasonable standard, there should be no debt ceiling. Among the developed world, only Denmark has a similar constraint, and that country never risks breaching its limit. Until the recent outbreak of legislative gridlock, routine debt ceiling increases generated occasional but relatively modest conflicts and were summarily resolved, since any policymaker advocating a repudiation of U.S. debt obligations was rightly viewed as not serious.

This time may be different. So far, markets are assuming that we will come to our senses and increase the debt limit. But it is important to understand that our representatives are juggling chain saws, and one false move could prove disastrous.

Christopher A. Hopkins, CFA, is a vice president for Barnett & Co. Investments and will answer your personal finance questions directed to dflessner@timesfreepress.com.

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