Below, MFR's resident political commentator, Bill Leary, CPA, JD, discusses the debt ceiling. The debt-ceiling debate will likely be the political fight of the year. Republicans hope to win a promise of spending cuts or a cap on future spending. Many Democrats will push back. It is anticipated that our debt-ceiling will be reached in May, with a possible delay until July if Treasury takes emergency steps.  If you are interested in learning more, contact Bill at wleary@mfrpc.com.

The Debt Ceiling Battle Heats Up

At the end of April, the national debt totaled just over $14,236 trillion, $58 billion below the current debt-ceiling of $14,294 trillion.  The Congressional Budget Office (CBO), Government Accountability Office (GAO), and the Office of Management and Budget have found, that absent policy changes, the amount of debt held by the public will become unsustainable.

This year, the CBO expects us to borrow another $1.5 trillion.  In just two years, we will have borrowed almost 20 percent of our gross domestic product.  It came as a surprise to many that PIMCO, the world’s largest mutual fund, dumped all of it holdings in Treasury securities because the yield offered is no longer high enough to compensate for the inflation risk in the United States.  As of mid-March, the yield is around 3.3 percent – lower than they were in 1962 – despite the debt-ceiling issue. 

As we have already seen this year, the federal budget process generates near-irreconcilable controversy.  Budget disputes, though, are often easier to deal with by passing continuing funding resolutions to delay decisions for weeks or months or longer.  On April 14^th a budget compromise of sorts was passed, cutting $38 billion from federal spending this year and keeping the government running for 6 months.  Voting against the measure were 59 House Republicans who broke ranks with their leadership.    

The budget compromise did not settle the government’s pressing financial issues because of its reliance on borrowing. Regardless of whether expenditures are accounted for in the budget (or off-budget), spending and, particularly, entitlement programs affect the federal government’s appetite for debt financing.  Reaching a budget resolution is very different than raising the debt-ceiling.  Increasing the cap on federal debt demands action that extends over the long-term to satisfy investors and it is almost always about how much higher it should go to support current and future spending and to cover on-going revenue short-falls – issues that will spark controversy in just about any conversation. 

In order to keep the government functioning, the Treasury Department borrows money, for example, by selling Treasury bills, notes, bonds and saving bonds to public -- it is literally the amount the U.S. government owes to domestic and foreign public borrowers.

Many of the top 5 foreign holders of treasury securities are also in the top 10 countries with which the United States has a trade deficit, according to the Census Bureau – a rebate of sorts.  In January of this year, foreigners owned $4.45 trillion of U.S. public debt, or approximately 47% of the $9.49 trillion held by the public and 32% of the total debt of $14 trillion, which, according to the Treasury Bulletin, includes borrowing from various federal set-aside funds such as social security (i.e., non-public debt).  For much of the world, Treasury securities are safe assets because the default risk is low and the U.S. economy is very large – two factors that keep the yield low. 

Between now and Congress’ summer recess in August, serious debate and compromise is expected.  CNN Money offers a succinct summary of the dialectic being played out:

The current political landscape has lawmakers scattershot across a variety of positions. The Tea Party (supporters), and the freshmen they sent to Washington, are opposed to raising the limit….Meanwhile, some Democrats have broken with the party line, and are now openly advocating for debt reduction measures to be attached to any measure that bumps up the ceiling….Other variables: What will the new limit be set at? Will any modifications to Medicare, Medicaid or Social Security be on the table...Washington in recent months has been buzzing with proposals to cut trillions of dollars from the federal budget (by President Obama and Rep. Ryan), and broad reforms to tackle entitlement spending.

According to Ben White of Politico, Wall Street executives and D.C. lobbyists have been voicing support for a quick deal.  In my view, it is likely that the debate and salvo of options under consideration will impact economic indicators, already exacerbated by oil prices, global unrest and natural disasters.  If the debate has an adverse impact on U.S. dollar exchange rates business and the economy, will suffer set-backs.

Although November elections are months away, the positions taken by Congressmen, all facing re-election, and Senators seeking another term will define them in the electorate’s mind. Like it or not, political posturing will play an important role in what will happens, the compromises reached, and any agreement on long-term measures to address the issues, will define this Session of Congress and will impact candidates for President who will be facing critical early primaries.

Between 1940 and 2009, the debt limit increased 90 times. Ten increases have occurred since 2001, taking us up to our current ceiling.  The magnitude of increases in the debt-ceiling recently has been dramatic. Defense spending, expenditures to stimulate the economy and tax legislation have accelerated our need for debt-financing.  Do these represent on-going deficit trends or extraordinary spending beyond our means?

Until recently, the House of Representatives routinely passed a resolution with the budget that changed the debt limit its budget bill. In 1974, the Congressional Budget Act established a new procedure requiring separate legislation to pass the debt limit. This legislation was passed so that Congress could debate the status and trajectory of the federal debt.  Historically, specific spending cuts or tax increases are considered as a serious option in debt-ceiling debates. 

Former Office of Budget and Management and Treasury officials, congressional staffers, and CBO employees -- have suggested, replacing the debt-ceiling with debt targets for lawmakers to work under.  Proposals by the President and members of Congress have suggested similar options, as well as spending cuts. Such major reforms are frequently deferred until a President’s second term.  

Recently, Politico suggested 5 possible outcomes to the crisis.   Attempting to read tea leaves is a game of speculation and political sport.  “Anyone who says they know how it could end is wrong,” said former Republican Rep. Vin Weber of Minnesota, a onetime ally of former Speaker Newt Gingrich, who may be in the presidential mix. “At the end of the day, (Congress) will still pass an increase of the debt-ceiling. [But] I think we’ll go through a period of market volatility leading up to it. ... It’s going to be a roller coaster ride.” This is not a good sign for an economy on the mend.