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Monday, June 6, 2011

Playing With Default

An extraordinarily dangerous problem, Greenspan says

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The current puppet play in Congress—where Republicans sponsored a bill to raise the nation's debt ceiling only because they wanted to vote it down—would be funny, if only they weren't risking economic disaster. Unfortunately they're not joking, as they push the country closer and closer to a potentially ruinous default.

If the showdown over debt and spending between the House majority and the White House isn't resolved before the first week of August, the federal government will no longer be able to send out Social Security checks, run Veterans Administration hospitals, pay Medicare costs or operate the national park system, to mention just a few significant items. Hundreds of thousands of federal workers would be furloughed without pay, and millions of seniors would stop spending money, slamming an economy that already seems stalled.

But the consequences of that unprecedented situation would reverberate around the world, as nearly every expert—from the top bond trader, Mohamed El-Erian, to former Federal Reserve Chairman Alan Greenspan—has warned.

Because both the U.S. dollar and U.S. Treasury notes are so important to world trade and investment, a default on U.S. debt could drive the global economy into a recession worse than that from which we have been slowly emerging. The same experts have warned against the Republicans' insistence that they force more budget cuts before they pass a higher debt ceiling.

Indeed, Greenspan is so concerned with the prospect of a debt default, either now or in the future, that he has advocated increasing taxes to the same level as before the George W. Bush tax cuts. Congress must approve a higher debt ceiling, said the conservative fiscal guru—or risk catastrophe if the United States does not meet its obligations. The brinkmanship that had led to the current impasse in Washington, he told CNBC, is "an extraordinarily dangerous problem for this country."

Risking Another Blow to America's Power and Prestige

Why is it so perilous for Republicans and their tea party backers to push toward default? The rating agency Moody's, following a similar warning weeks ago from Standard & Poor's, is threatening to downgrade U.S. Treasury securities if an agreement isn't reached within the coming month. Such a historic event would be much worse than embarrassing—and the Moody's analysts now believe that a default is increasingly likely.

"Although Moody's fully expected political wrangling prior to an increase in the statutory debt limit," said a statement issued by the ratings firm, "the degree of entrenchment into conflicting positions has exceeded expectations."

Political polarization over the debt limit "has increased the odds of a short-lived default," it said, meaning that Moody's doesn't believe even the Republicans would permit the default to continue. But the nasty reverberations of even a brief default could last far longer, with sharply rising interest rates, crashing stock prices, a plunging dollar and yet another blow to America's prestige and power.

Most economists also believe that the Republican insistence on cutting spending in a slowing recovery is simply wrong because it will reduce demand and cost jobs. The party's congressional leaders have yet to explain how they will boost the economy by throwing yet more people off federal and contractor payrolls, which will further depress the housing market, as well.

Remember that these are the same geniuses who opposed the auto bailout two years ago—which has now proved not only to have saved hundreds of thousands and perhaps millions of jobs, but at a very low cost. Somehow they seemed to believe that Europe and China should build cars while we let our auto industry wither.

While cutting spending and restraining the debt sound appealing, they must be done with great care. The Republican claim that there will be no harm in approaching default, or actually defaulting, is ridiculous to anyone who actually understands how markets work—and the damage they can sometimes wreak.

© 2011 Creators.com

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