The United States hit it’s self-imposed debt ceiling this week, marking another stop on the complicated and contentious journey in Washington to cut government spending and chip away at debt.
Treasury Secretary Timothy Geithner broke the news to Congress Monday, saying the government will now take steps to create space beneath the $14.294 trillion cap so the government can continue borrowing. That, he said, will work only to Aug. 2. He also asked Congress to raise the ceiling but some lawmakers say doing so without drastic changes in the country’s spending habits will cause further damage to the economy.
Goizueta’s Ray Hill, Assistant Professor in the Practice of Finance, says politics will continue to play a major role. He said even with a long-term budget fix the debt ceiling will need to be adjusted in the future.
“It’s a clash or religions,” Hill said, comparing the stance of many Democrats and Republicans. “One is a religion that says you can’t cut too fast because we’re going to destroy the economy and another religion that says cutting spending is exactly what we need for the economy to recover. The question is whether politicians will miscalculate in this game of ‘chicken’ and we go into a financial crisis because we do this in a disorderly way.”
Hill said the nation isn’t at immediate risk of defaulting on its obligations, adding even in a government shutdown revenue could cover interest payments. According to The Wall Street Journal, the U.S. hit the debt ceiling in 1995 and 1996. A similar standoff between the Clinton White House and House Republicans ensued but a deal was reached.
But the current debt crisis is unlike anything the nation has faced.
Hill said there’s not much fear in the markets right now about the United States paying its bills and raising the ceiling of allowable debt itself wouldn’t derail the economy. But lump in change in spending and there are various scenarios.
Currently the government faces paying its bills late or continuing to run very large deficits which, according to Hill, could create a significant erosion in the value of the dollar and cause the market to turn away from treasury bonds.
“What people need to have as a memory of this is in the 70s and the early 80s when oil producers accumulated large portfolios of treasury bonds and other dollar securities because of the run-up in oil prices,” the professor said. “Then we had severe inflation and a steep fall in the dollar and the value of those bonds dropped tremendously. At some stage, if we don’t deal with these huge deficits, people are going to say ‘I’m not going to buy your treasury bonds anyway because the dollar is going to decline significantly relative to other measures of value in the world.'”
There’s no proven path for success, leaving the door open for lawmakers and economists to debate issues through the summer. Hill said he predicts the two sides will come together for a solution, but that doesn’t change the rhetoric from battling ideologies.
“We can’t prove a right answer on one side or the other,” he said.