If one second is one dollar then a million dollars is 11.5 days and our national debt is 457,000 years. So does it matter if we raise the debt ceiling?
We have already indirectly defaulted. The question now is do we want a hard landing or a soft landing?
Back on May 16th, 2011 we officially hit the debt ceiling limit of $14.294 Trillion. Our treasury secretary, Timothy Geithner, bought us some time until August 2nd by raiding retirement funds. But don’t worry too much; he replaced the cash with IOUs or US treasury bonds. Interestingly the news outlets and rating agencies have saved the fireworks for now.
The drama that you see unfolding between the blue and red teams may be irrelevant at this point. The real meat of the matter can be found in the major players: the Federal Reserve and China.
The government is currently spending between 4 and 5 billion dollars a day and about 40-50 cents on every dollar is borrowed. In the past decade, China and Japan have been our largest creditors. However, since 2008 they have greatly reduced their purchases of long term treasuries. Recently, the Federal Reserve has passed China as the largest holder of US treasuries. This is no surprise with the Fed purchasing roughly 80% of the long term US treasuries every month since 2009. The Fed’s purchasing plan has allowed China and Japan to reduce their holdings making the Federal Reserve the new, most powerful creditor on the block.
A hard landing may occur if a debt limit deal is not reached by August 2nd. It would result in selling and panic in the markets and subsequently a deflationary scare like we saw in the latter part of 2008. The good news is this will not happen. As the largest US-debt holder and creditor of the US government, the Federal Reserve has the greatest incentives to keep the markets confident in US assets. The key metric: bond yield, has been unfazed by the debt drama.
At this point the most logical solution is the most unpopular one: Spending cuts accompanied with tax increases. If we don’t generate some income to balance out our expenses then we will continue to add to the already blooming debt. The deeper we climb into debt, the less likely there will be willing purchasers of our bonds. As the demand for bonds fall, the federal funds rate (interest rate) will need to rise in order to attract new customers. If interest rates climbed to 6%, interest payments on the debt would skyrocket– adding another 5 trillion dollars to our national debt.
This time it may be different because we have the Fed willing to purchase as many treasuries as it needs to in order to keep a low-interest environment. In exchange for US government treasuries the Fed gives the government freshly printed dollar bills to spend at its will. With politicians accelerating spending to combat the recession and deliver on promises, it won’t be long before the markets are flooded with too many dollars. A regimen of money printing and loose credit will delay the pain for the time being but eventually hyperinflation could set in.
The truth of that matter is that we can keep getting drunk on the Government’s punch or we can sober up and face reality. The hangover will come inevitably.
It appears as if a deal has been struck. $1 trillion cut over 10 years, with another $1.8 trillion TBA. Personally I think the deal doesn't cut enough and isn't nearly as effective without a tax increase. Sure raising taxes in an economy like this could potentially be harmful, but we need to close tax loopholes and raise taxes on the wealthy. Spending, not revenue, is the true problem, but whose to say revenue can't help the situation. I feel like Obama has bent over backwards once again for the Republican Party. He might as well run for the Republican Party in the next election because he's not a true Democrat and lets face it, the Republicans don't have a competent nominee as of yet.
ReplyDeleteThe war on terror (Iraq & Afghanistan) is the first time in history of the world that a war was accompanied by tax cuts. Generally the basic formula goes: war = increase in taxes... Until the people get too upset with the tax increases and start denouncing the wars. I agree with closing loopholes, but having more of a progressive income tax isn't going to affect the rich for they make a majority of their money in stock [capital gains tax]. They also have other ways of dodging it. In the end, I think the upper middle class will take most of the burden because they dont have the cayman island or swiss bank accounts.
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