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Politics & Government

The National Debt Crisis: Too Close for Comfort

The national credit score is everybody's problem. Residents, federal employees and businesses in north central Connecticut will be in a bind if the U.S. government fails to send out checks on Aug. 3.

Democrats in Washington, D.C. could learn a lesson or two from Gov. Dannel P. Malloy on how to overcome political differences and take swift action during a crisis.

In the aftermath of a recession, Malloy tackled a looming state budget deficit by implementing both tax increases and spending cuts, is minimizing the size of local government and holding his ground with Connecticut state unions. You may or may not agree with his economics – but at least we have a governor who is taking a hard look at the state’s balance sheet and is unafraid of making unpopular decisions. 

In contrast, just days before the U.S. government is scheduled to meet its payment obligations on Aug. 3, the day after U.S. Treasury funds dry up, Democrats and Republicans nationwide are still mired in political rhetoric instead of focusing on economic realities – which is to raise the $14,300 billion debt ceiling. 

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While the risk of the U.S. government defaulting on its sovereign debt obligation is inconceivable, the possibility of missed payments in the short-term is very real. U.S. rating agencies have, as expected, raised the red flag. Both Moody’s and Standard & Poor’s have announced a possible downgrade, and Egan-Jones has downgraded the U.S. sovereign credit rating from triple A to double A, which will undoubtedly increase the cost of borrowing going forward.

I spoke to some local voices across north central Connecticut to see what they thought about the political wrangling at the nation’s capital, and what this crisis means for our region.

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“Many people in our business community have expressed their concern to me on the uncertainty at the national level,” State Rep. David Baram, D-Windsor, who also represents Bloomfield, said.

“They said they are holding back on investing and creating jobs here because they fear whether their money will be safe tomorrow,” he said, referring to the inevitable devaluation of the dollar if the U.S. Treasury fails to send out checks due after Aug. 2, the last day when sufficient money will be available to meet obligations.

“Sooner or later, a crash is coming, and it may be terrific,” economist Roger Babson cautioned in 1929, at the verge of the Great Depression. But the situation today is not quite as bad. The reason? Economists concur that the U.S. will still continue to pay its interest rates on debt, thereby avoiding an actual default  – hallelujah for that. But it could default on payments such as social security, unemployment benefits, Medicare, and on salaries to federal employees, which constitute a technical default.

“The most likely scenario is a technical default. However at some point, the government will make good on all of its payment commitments, but until a political resolution is reached, it must decide whom it will short. In other words, who is most likely to not receive a check after Aug. 2?” Fred Carstensen, an economist at the University of Connecticut, said.  

“It is a stunning piece of utter irresponsibility not to raise the debt ceiling on time. The Republican narrative is so irrational. But both Republicans and Democrats are exhibiting a historical and theoretical illiteracy in this debate,” Carstensen said.

President Ronald Reagan famously declared in his inaugural address: “Government is not the solution to our problems; government is our problem.” Ironically, that statement could very well be applied at this time to those politicians who are wrangling for spending cuts before they agree to raise the debt ceiling.

“You don’t solve the problem of national debt by committing economic suicide. Not raising the ceiling on time will profoundly affect America,” Carstensen warned. “As far as I can tell, there is nothing in economic theory that suggests that there is any relationship between spending cuts and the government’s ability to pay its bills.”

Fellow UConn economist Steven Lanza, executive editor of The Connecticut Economy, said though not raising the debt limit would seem like a way to keep the cost of government in line, the opposite is true. Default, or near-default whereby the government eventually makes good on its obligations including any necessary penalties, would raise the cost of future borrowing. That means we’d no longer be able to issue new debt at rock-bottom interest rates, or refinance old debt cheaply. The cost of servicing the debt would skyrocket.

“Not raising the debt ceiling in time means the U.S. will likely cut spending – for example, not send out Social Security checks – to avoid outright default,” Lanza cautioned. “But that would cast a dark shadow over the economy, chilling aggregate demand just at a time when already weak demand is putting the current recovery in jeopardy. That would also roil financial markets, putting recent gains in 401k etc. at risk, and eroding the equity that households have managed to rebuild over the last couple years.”

Few people would disagree that America is sitting on a mounting debt bomb that will implode on our faces if we don’t diffuse it in the long-term.

Windsor Town Councilman Ronald Eleveld asks readers to take a look at http://www.usdebtclock.org/, a site that is frequently referred to when citing data on national debt.

“The debt ceiling must be raised in order to avoid a calamity (even though) a higher ceiling will allow Congress and the President to go back to business as usual, and rack up more debt,” Eleveld said. 

To prevent this, Eleveld said he is in favor of a Balanced Budget Amendment, a proposal by Senate Republicans to amend the constitution (Article V), to make balanced budget a requirement. Libertarian Sen. Ron Paul is urging Congress to call for an Article V convention.

“We need a Balanced Budget Amendment. The alternative is a continuation of more creative accounting and still more creative ways of adding to the debt,” Eleveld pointed out.

“I think a no holds barred, no exceptions Balanced Budget Amendment maybe required to get the government to live within its means, but no politician will want to tie his/her hands. It is always more fun to give away someone else’s money to others if it means you have a better chance of getting re-elected,” he said.

Lanza strongly disagreed with this proposal on the grounds that it would muzzle the government’s ability to respond with discretionary fiscal policy measures in times of need. Moody’s has even called for a removal of the debt ceiling entirely.

“A constitutional amendment to balance the federal budget is a bad idea and always has been. Deficit spending is critical to the federal government’s ability to exercise countercyclical fiscal policy. Those efforts in the last few years have kept the Great Recession from turning into The Great Depression – the Sequel,” he said. “Without that ability, the U.S. economy would be hostage to free market forces, for good and for ill. Policymakers should aim for a budget that balances over the course of the entire business cycle, not one that balances every year regardless of circumstances.”

Also, where do we make spending cuts?

“We can start with two departments. The education department that does not directly educate kids but does a great job of moving paper, and is redundant on the state level, and the energy department that produces no energy,” Eleveld said.

Keynesian economists will abhor any cuts – defense or welfare – at a time when the federal unemployment rate is at 9.5 percent, citing the damage to the economy when the public sector contracts its spending.

“When real wages decrease, we must increase aggregate demand. It’s the only way,” UConn’s Carstensen said. “The U.S. private sector and public sector debt combined is more than 220 percent of the gross domestic product. But the government simply cannot reduce its debt the same time as the private sector, because the economy will fall.”

So what then is the solution?

Damon DelMonte, a banking analyst at Keefe, Bruyette & Woods, Inc., tracks People’s Bank, First Niagara, Rockville Bank and Webster Bank, all of which have branches in north central Connecticut.

“All of these banks are fundamentally sound and there will be no immediate impact on credit availability to local communities if the national debt ceiling is not raised in time. But I’m confident Congress will resolve this,” he said.

“However in the long term, we have to address our debt by raising federal taxes and cutting back on federal government spending. And this is going to impact our communities.” 

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