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Analysis/Comment Last Updated: Jul 1, 2011 - 8:08 AM


Dr. Peter Morici: No US default, no shutdown inevitable if debt ceiling talks fail
By Professor Peter Morici
Jul 1, 2011 - 6:38 AM

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Chairman of the Joint Chiefs of Staff Admiral Mike Mullen, President Barack Obama, and Secretary of Defense Robert M. Gates salute as troops parade past the reviewing stand during the Armed Forces Farewell Tribute in honour of Secretary Gates at the Pentagon in Arlington, Virginia, June 30, 2011.

Dr. Peter Morici: The United States does not have to default on its debt, and the social security and Medicare checks can go out even if Republicans and President Obama cannot strike a deal to raise the debt ceiling by August 2.

Even though the government cannot borrow additional money, it still has tax revenues equal to about 55% of expenses - - $2.2trn against expenses equal to about $3.8trn for a $1.6trn deficit. With those tax revenues, Washington can fund interest on the national debt, social security, Medicaid, and crucial national defense responsibilities. With the interest on the debt honored, the government can sell new bonds to replace bonds that come due without piercing the statutory debt limit.

Interest, benefits to seniors and defense would absorb virtually all tax revenues. It would appear the other functions of government would have to shut down, but the Administration has other options.

Often overlooked, the Treasury can print money to pay its bills. Before you gasp that Washington would be flooding the world with greenbacks—it doesn’t have to be.

The Federal Reserve holds on its balance sheet about $2.6trn in securities, mostly Treasury bonds, which it could sell to absorb the money the Treasury prints to pay its bills. At $1.6trn a year, that could keep the government running past the next election.

Also, since 2007, government spending has jumped $1.1trn but only $200bn was needed to cover inflation—the $900bn additional was new programs and benefits and higher pay. That has increased federal spending’s share of GDP from 19.6% to more than 25%.

Temporarily, slicing that additional government spending by $450bn, by executive order, would likely stand up in court as an emergency measure. Especially if President Obama and Secretary Boehner sat down and did a deal, alone and with no help from their partisan friends but if necessary.

It would be good politics for both sides—either the President is right and Americans would see how painful it is to cut government that much, or Republican would be able to point that we are better off.

The Treasury would have to print about $1.2trn a year in new money, and the Fed would sell an equal amount of securities from its balance sheet; however that maneuver would take us until a new Congress is seated and a reelected President Obama or his successor has a clear mandate.

Before you say this is kicking the can again, consider that in 2012, both the President and his opponent would have to table specific alternatives for slashing the deficit and restoring normal operations, and the winner would emerge with a mandate for his plan.

Right now, neither side is tabling credible plans. The president’s taxes on the rich and other schemes would only slash at best $150bn annually from the $1.6trn deficit, and the Republicans about a similar amount in spending cuts they have managed to propose.

Neither side is talking about harnessing the rapidly rising prices the government pays for health care—both sides just talk about trimming benefits a bit or the pain of it. 

The United States pays double, or more, than European governments for drugs, and suffers from large disadvantages in insurance administration, hospital efficiency and tort costs. Regulating those prices is tar baby no one in Congress or the White House wants to put his arms around - - but we are not getting out of this mess without doing so.

Ditto for retirement ages for social security and the vast array of federal pensions, and state pensions the federal government indirectly helps finance.

The absence of frank discussion of financing options beyond August 2 is the fault of two men. Though Treasury Secretary Geithner serves at the pleasure of the President, and Fed Chairman Bernanke must answer frequently to Congress, both men have a responsibility to articulate the genuine budget and economic challenges before the nation, and both men can easily find other satisfying and better paying jobs in a pinch.

In similar crises, past cabinet members have stepped up—consider the conduct of senior Justice Officials in the last days of the Nixon Administration, and Alan Greenspan was not afraid to talk frankly about federal policies.

Secretary Geithner needs to draft plans to keep the government going and be quietly frank with political leaders about those plans. And, Chairman Bernanke would then concur with how the Fed can respond.

Sadly Geithner and Bernanke are shirking responsibilities. Geithner’s substantive shortcomings are widely speculated; however, Mr. Bernanke is a bright man and has no alibis to offer.

Peter Morici,

Professor, Robert H. Smith School of Business, University of Maryland,

College Park, MD 20742-1815,

703 549 4338 Phone

703 618 4338 Cell Phone

pmorici@rhsmith.umd.edu

http://www.smith.umd.edu/lbpp/faculty/morici.html

http://www.smith.umd.edu/faculty/pmorici/cv_pmorici.htm

Goolsbee Talks Economic Recovery: Austan Goolsbee, Council of Economic Advisers chairman, assesses whether the economy will improve and whether a tax hike is the answer for solving America's debt ceiling debate:

Greenspan One-on-One:

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