Debt Ceiling

In short, if the United States defaulted on it’s debts, the entire world economy would go in a catastrophic tailspin.  Since so many countries use the U.S. greenback as their reserve currency, the ricochet effect would hit each of the world markets instantaneously, and a great deal of wealth would be lost across the board.  Interest rates would skyrocket, and inflation would settle in.  United States Treasury Bonds (T-Bills), often considered the safest investment in the world, would be downgraded from the AAA credit rating that every other security and bond in the developed world is measured against.  The price of gold and silver, generally considered to be recession-proof instruments of last resort, would go through the roof.  

The initial shock this would have on the market is not in question.  The only question is, why would the richest nation in the world would choose to self destruct its own economy?  As stated early, the only reason is political.

Scarcity & Abundance; Risk & Reward

One of the most important premises of economics is that the condition of the world is one of scarcity, and that people have unlimited wants.  This may be one of the reasons that economics is consistently referred to as ‘the dismal science’.  On the other hand, a great deal of the personal wealth advice literature is based on the premise that one of the first things an individual needs to do to attain wealth is start thinking and behaving like the world is one of abundance.  Why the disparity?

People tend to be risk averse.   If they had their way, they wouldn't put themselves out there if there wasn't something in it for them.  There are exceptions to the rule.  Risk tolerance ranges from risk averse, downstream to risk taker, and past the rational into the world of the risk lover.  Risk takers tend to make calculated decisions between risk and reward, whereas risk lovers tend to take risks just for the adrenaline rush, despite plenty of evidence against the wisdom of such an action.

In general, risk averse people tend to keep their money in the safest investments: U.S. Treasury Bonds, cash in FDIC-insured bank accounts, gold, silver and other precious metals.  Risk averse people utilize mutual funds as opposed to picking and choosing equity positions in specific securities because portfolio theory has shown empirically that spreading one’s investments over several different holdings is safer than the investment equivalent of ‘all one’s eggs into one basket’.  

If the risk averse people are relying on the full faith and credit of the United States to make good on it’s debts, then it’s fair to say both the risk takers (the day traders playing individual stocks and commercial paper on a daily basis) and the risk lovers (the guys at the high stakes tables in Las Vegas) are betting that the dollar bill may appreciate or depreciate slightly against other world currencies, but for the most part when they go to bed their entire fortunes won’t be blowing in the wind.  In short, everyone is holding onto their money because of uncertainty.  If the U.S. defaults, everything PROMISES to become more expensive for the U.S. consumer, and the only question is how many factor multiples it will tumble from the time the U.S. Treasury is hamstrung by Congress by creating this self-inflicted disaster.

The fundamental tradeoff between risk & reward will be amplified.  Everything becomes more risky, so everything costs more.  People in the low income brackets’ wages are non-existent or frozen, and it becomes more expensive for a wage earner to fill up their tank of gas and drive to work than to just sit home.  People with holdings in the stock market will suffer a double-whammy, as stock prices are sure to fall while the dollar falls in value.  Smaller investors will rush to get out of losing positions, potentially from facing a margin call, and end up taking pennies on the dollar.  The incentive for investors and hedge funds to take a short position in certain equities will drastically increase, and accelerate the wealth loss in the market capitalization of corporations.  

The Federal Reserve Bank will lose its only real tool to stimulate economic growth, the monetary supply.  Rising interest rates will make people’s mortgage payments to increase in turn, and people’s credit card debt will accumulate interest in staggering amounts.  The entire credit market will come to a crunch, as each business and individual relying on loans will be turned away as the banks themselves will have a hard time paying their debtors.  After all, no one’s paying the bank either.  If any of this sounds frighteningly familiar, it’s exactly what happened when the global economy and banking industry stopped functioning in 2008, when the government was forced to make billion dollar bailouts across the banking industry ostensibly to keep the world from spinning off its axis.

Voodoo Economics

The intention of the Republican Party in the House of Representatives to slow down economic growth is reliant on a belief in supply side economics.  In short, they believe that the private sector and wealthy individuals should get lower taxes, and that those entities will turn around and spend that money and more jobs will be created.  There is no empirical evidence that anything of this sort actually happens.  In reality, wealthy individuals hold onto that money, and corporations pay the bulk of those profits to high level executives.  There is no “trickle down” effect.  The rich get richer, and the poor get poorer, and this gap has consistently widened in each experiment with supply side economics.

The threat to not raise the debt ceiling is a bluff.  But if the White House blinks and begins agreeing to cut the size of government spending as a result of the empty threats of the House majority, then the recovery is due for a stall, a stop, and a reversal.  There will be less jobs, less money flowing through the economy, and everyone will be worse off.  Even the wealthy.  But they won’t be living hand in mouth.  And politically, it will be easier to make the case that the White House is the reason that the economy has tanked.

The President is Smarter Than That, AND Smarter Than You & I For That Matter

The bulk of the negotiating over spending cuts have already been made through the President’s previous advances in his agenda.  By drawing down troops and ending the expensive wars in Iraq and Afghanistan, the President has already set the stage for more than enough cuts to match the demands of the House majority.  

The House majority doesn’t know how to make a budget because they’ve been relying on voodoo economics as a crutch for as long as they’ve been deifying Ronald Reagan.  The Ambidextrous Economist will feel a lot better personally when the GOP’s budget proposal stops being called “The Ryan Plan”.  (I’m talking at you Paul Ryan (R)-WI:  Take an economics class.)  

Furthermore, the savings from the Health Care Affordability Act will dwarf any attempts by the right wing to end Medicare, gut Medicaid, lower Social Security benefits to the retired and disabled.  The repercussions from ending these safety nets would cause the very economic fallout that they’re currently trying to manufacture.  

It's worth restating.... The best thing a country can do when they’re experiencing the slowing down of growth is deficit spending.  Why make cuts now?  It’s a tactic to create an impression that the White House isn’t competent on the economy and creating jobs.  But the facts will show that the bulk of the fiscal responsibility has been on the part of the White House, and the efforts of the House Republicans have been largely positioning themselves for a false narrative they can run on in 2012.

How Will This End Up?

Publicly, the President will concede that spending cuts need to be made.  The Ambidextrous Economist thinks that behind closed doors, he’ll offer very little in the way of cuts that he hasn’t already made through the bargaining rights through the Affordable Health Care Act and by restructuring the budget for the Pentagon.  

Looking back at the history of negotiations thus far, The President presented a budget that received no votes for approval in the Senate.  Basically he shot a blank.  Then Rep. Paul Ryan (R)-WI released a budget to end Medicare.  The House approved the budget to end Medicare.  This led to a great deal of political fallout as evidenced in the New York state special election, where a staunchly conservative district went blue for the first time in recent memory.  Since then, there’s been a lot of political posturing, but both sides continue to be working off budgets with very different assumptions built into them.

The President has a trump card.  Should the Congress be unwilling or unable to raise the debt ceiling, the U.S. Constitution has the answer.  Article 14, Section 4 reads:  

The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned.

Forget about all the bad things that could happen.  There won’t be Armageddon in the world marketplace.  The one thing everyday Americans should worry about in the time between the now and when the debt ceiling is eventually raised is... Will the White House and the Democrats in Congress cave in on Republican spending cuts designed to stave off the progress the economy has made in recovering from the Great Recession in 2008?  If you don’t remember back to 2008, that’s when the wondrous glory of supply side economics was on full display.

AE - 07.08.2011

The Ambidextrous Economist leads with the left & doesn’t miss.  He can be reached at