Volume XVIII No. 41

One of the problems with brinksmanship is you’re never really sure what’s going to happen when you’ve gone over the brink. Treasury Secretary Jack Lew has indicated that on or about October 17, the U.S. Treasury would be on the brink of not being able to pay all of the federal government’s debts. That is because the $16.7 trillion debt limit would be reached and the Treasury would only be able to spend what it takes in – hand-to-mouth government. We’re all about balancing Uncle Sam’s books, but this doesn’t accomplish that, it just delays repayment of legitimate debt.

The debt limit is the Congressionally-set statutory limit on how much the Treasury can borrow to pay its bills. Once that limit is reached, there can be no more borrowing; it’s all on cash in – cash out basis. There are all sorts of theories and possible machinations propounded how the debt limit can be evaded: mint a trillion dollar platinum coin and deposit it in the Treasury, prioritize payments to pay off public creditors, reinterpret the 14^th Amendment to the Constitution so debt limit doesn’t even matter. But “evaded” is the critical word here. Because when it comes to the full faith and credit of the U.S. Treasury, how actions are perceived is as important – or even more important – than the technicalities. Even if the U.S. declares it didn’t default, if the world, and our creditors disagree then the Treasury is going to have pay a lot more interest to get them to buy our debt.

Today, the dollar is the reserve currency of choice for the world. Its relative stability and the widespread belief that U.S. will always pay its debts means other countries and individuals want to park their cash here by buying U.S. securities or T(reasury)-bills. International Monetary Fund data reveals that more than 60 percent of the world’s allocated reserves are in U.S. dollars. That desirability means that the government doesn’t have to pay these creditors much in the way of interest to entice them to buy the nation’s debt. However, the U.S. share has decreased from more than 70 percent as recently as 2001. If the U.S. debt becomes less desirable, the country has to pay higher rates of interest. Already, the federal government paid more than $220 billion in net interest last year.

But net interest isn’t the only bill the government pays each year. In fact, the Congressional Budget Office estimates the government spent $3.5 trillion in fiscal year 2013, far outstripping the total revenues of $2.8 trillion. Just like a family has household expenses other than the interest on the credit card balance, the federal government pays contracts, salaries, retirement benefits, and so on. To not pay some of these creditors would be akin to a structured bankruptcy, prioritizing certain creditors.  Whatever it looks like, it will be seen as default across the world and in the eyes of the financial markets.

There’s no easy way out of our nation’s difficult fiscal situation. But the answer isn’t playing chicken with the debt limit and jeopardizing the world’s belief in the full faith and credit of the U.S. Treasury. Policymakers need to increase the debt limit. And they need to figure out solutions to our fiscal situation. Federal spending has decreased two years in a row for the first time in decades, and that coupled with increased revenues from the improving economy has reduced deficits from record highs. But, starting in fiscal year 2015, the budget will start rising again and with rapidly rising entitlement spending the budget deficits will begin to increase dramatically. In the meantime, Congress and the President need to tackle tax and entitlement program reform. Our tax code needs to be fairer, flatter, and simpler and the litany of breaks and giveaways have to be done away with. The entitlement programs, particularly Medicare, need to be put on sounder financial footing as the baby boomers retire, stressing the system even more.

Yes, raising the debt limit won’t solve any of our nation’s fiscal challenges., But not raising it will make those challenges even harder.