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Silly Worry of the Day: US Will Default; Politics of the Debate

By: Mike Shedlock | Thursday, January 10, 2013

Of all the over-dramatized nonexistent threats, the silly worry of the day is the US is at risk of default if Congress does not raise the debt ceiling.

Earlier today, I saw a couple of articles outlining how and why a US default could happen. Well, it won't, and there is no need for all the surrounding drama either.


Ending the Debate Drama

The best rebuttal to the default idea comes from Bloomberg columnist Caroline Baum in her article Obama's Default Drama Is No Way to Run a Country.

The United States of America isn't going to default on its debt, even if Congress doesn't increase the statutory borrowing authority in the next couple of months. Everyone in Washington knows, or should know, this. Any assertions to the contrary are tantamount to playing politics with the debt ceiling.

A shutdown is certainly possible. A debt default? Not gonna happen.

Why? Because the income taxes withheld from most of our paychecks each month exceed the interest the Treasury owes on its debt outstanding. In November, for example, the Treasury's interest expense totaled $25 billion. That compares with tax receipts of $161.7 billion. The ratio of receipts to interest expense varies from month to month, but what comes in more than covers what goes out in debt service.

Without an increase in the $16.394 trillion debt limit, the federal government can't pay all of its bills: It borrows 40 cents of every dollar it spends. Still, "debt service would come first," said Lou Crandall, chief economist at Wrightson Icap LLC in Jersey City, New Jersey.


Politics of the Debate

The idea of a default should end right there, but it won't. Here is a likely seven-point scenario.

  1. Obama will chastise Congress with talk of financial Armageddon if Congress does not raise the debt ceiling.
  2. Congress will pretend to hold the president hostage
  3. The secretary of the Treasury will get into the act with its own version of the default debate
  4. Perhaps a few payments on non-critical budget items will be temporarily skipped
  5. Wall Street will feign panic
  6. Constituents will pressure Congress to approve a new debt ceiling
  7. Congress will raise the ceiling with another useless warning about next time


What's Wrong With the Debt Ceiling?

Yesterday Baum wrote Only Thing Wrong With the Debt Ceiling Is the Lag.

Lots of people want to get rid of the debt ceiling, the federal government's statutory borrowing limit. When one considers that it enables the Treasury to borrow money Congress has already spent, it seems like a silly relic. Even worse, the vote to increase the debt limit has become a political football, with each party using it as an opportunity to extract concessions from the other. No wonder some folks say it's time for it to go.

Not so fast. The problem with the debt ceiling isn't the concept: the president and 535 members of Congress need a symbol to remind them just how much they spend each and every day. Rather, the problem is the lag relative to decisions on spending.

Then I thought of my friend Bob Laurent, economist extraordinaire, who died in 2005. Bob spent most of his career at the Chicago Fed. When the Fed was having trouble hitting its money supply targets in 1979, Bob came up with a simple solution (it was considered controversial at the time). Instead of the existing system of lagged reserve accounting -- banks' required reserves were determined by the level of deposits two weeks earlier -- Bob proposed a lead, or "reverse lag," method wherein the Fed would set the level of required reserves today and the banks would have to adjust deposits accordingly.

Therein lies the answer to the debt-ceiling dilemma: adopt Bob's lead, or "reverse lag," system. For those who say they want to cut spending, here's their chance. Right now, the sky's the limit. Congress needs to set the borrowing limit first and work within those confines. At minimum it will separate the real, limited-government advocates from the false prophets.

No platinum coins needed, no test of the president's powers under the 14th Amendment. Just reverse the lag. Bob thought of that a long time ago.


Not Quite

The problem with the reverse lag theory is the deficit is a function of two items: revenue and spending. Even if Congress gets a grip on spending (rather doubtful to say the least) revenues are all but guaranteed to fall short of CBO expectations.

Deficits will be above expectations and the debt ceiling will need to rise as a result.


More Coin Silliness

Yesterday someone emailed me proposing to use the platinum coin as a trust fund for Medicare. Good grief.

That proposal is exactly the kind of blatant free-lunch stupidity Pater Tenebrarum at the Acting Man mentioned to me in an email.

I added Pater's email as an addendum to my article Reader Questions on the 1 Trillion Coin Proposal: Where's the Money Come From? Will It Cause Inflation?

Addendum

Here are a few thoughts from Pater Tenebrarum at Acting Man

"I would point out though that whether it is inflationary depends on the precise mechanics of the operation. Congress could limit spending according to whatever it decides, so it need not be inflationary. But that depends on an unknowable future. As a rule, once government bureaucrats discover "innovative" financing methods, they try to make use of them to the hilt. The whole debate is actually a great illustration of the utter absurdity of our monetary system."

When I suggested minting a quadrillion dollar coin would not be inflationary, it was under my stated provision that Congress would still limit spending to amounts authorized. Of course, monetizing a trillion dollars every year is in itself an inflationary practice in isolation (with or without mind games involving platinum coins). The coin is irrelevant in that regard.

Pater catches the key point of both my articles in his concluding sentence "The whole debate is actually a great illustration of the utter absurdity of our monetary system." And that is precisely why I proposed Alfred E. Neuman on the coin.


Former Head of US Mint Chimes In

Philip Diehl, Former Head of the US Mint made a comment on Pragmatic Capitalism, reposted as an article that Addresses Confusion Over the Platinum Coin Idea. Here is the key section.

* What is unusual about the law (Sec. 5112 of title 31, United States Code) is that it gives the Secretary complete discretion regarding all specifications of the coin, including denominations.

* Moreover, the accounting treatment of the coin is identical to the treatment of all other coins. The Mint strikes the coin, ships it to the Fed, books $1 trillion, and transfers $1 trillion to the treasury's general fund where it is available to finance government operations just like with proceeds of bond sales or additional tax revenues. The same applies for a quarter dollar.

* Once the debt limit is raised, the Fed ships the coin back to the Mint, the accounting treatment is reversed, and the coin is melted. The coin would never be "issued" or circulated and bonds would not be needed to back the coin.

* There are no negative macroeconomic effects. This works just like additional tax revenue or borrowing under a higher debt limit. In fact, when the debt limit is raised, Treasury would sell more bonds, the $1 trillion dollars would be taken off the books, and the coin would be melted.

* This does not raise the debt limit so it can't be characterized as circumventing congressional authority over the debt limit. Rather, it delays when the debt limit is reached.

* Yes, this is an unintended consequence of the platinum coin bill, but how many other pieces of legislation have had unintended consequences? Most, I'd guess.

Philip N. Diehl 35th Director United States Mint


Accounting Gimmick

As I stated, the proposal is nothing more than an accounting gimmick. Even Krugman realized as much, specifically stating at the end of Debt in a Time of Zero "not everything is a free lunch, even now. Sorry."

To that I would reply, nothing is a free lunch ever, unless you count sunshine and rain as free lunches.


Benefit of the Debate

In spite of the silliness of it all, there is still a benefit of sorts to the debate. The benefit is that the American public gets to see what fools they have elected to Congress.

Since some might not find that much a benefit, so I have another idea. Stop paying Congress, the President, Vice President, and all their staffs, followed by everyone in a federal office, the second the debt ceiling is reached.

That would probably light a fire under the whole lot of them immediately.

 

Author: Mike Shedlock

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Mike Shedlock

Michael "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Visit http://www.sitkapacific.com/ to learn more about wealth management for investors seeking strong performance with low volatility.

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