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Default could destroy U.S. economy

By TOM RAUM
April 24, 2011

James Dimon, chairman and CEO of JP Morgan Chase & Co., speaks in New York. The United States has never defaulted on its debt and leaders from both parties say they don’t want it to happen now. But with partisan acrimony running at fever pitch, and Democrats and Republicans far apart on how to tame the deficit, anything could happen. (AP Photo/Mark Lennihan, File)

The United States has never defaulted on its debt and Democrats and Republicans say they don’t want it to happen now. But with partisan acrimony running at fever pitch, and Democrats and Republicans so far apart on how to tame the deficit, the unthinkable is suddenly being pondered.

The government now borrows about 42 cents of every dollar it spends. Imagine that one day soon, the borrowing slams up against the current debt limit ceiling of $14.3 trillion and Congress fails to raise it. The damage would ripple across the entire economy, eventually affecting nearly every American, and rocking global markets in the process.

A default would come if the government actually failed to fulfill a financial obligation, including repaying a loan or interest on that loan. The government borrows mostly by selling bonds to individuals and governments, with a promise to pay back the amount of the bond in a certain time period and agreeing to pay regular interest on that bond in the meantime.

Among the first directly affected would likely be money-market funds holding government securities, banks that buy bonds directly from the Federal Reserve and resell them to consumers, including pension and mutual funds; and the foreign investor community, which holds nearly half of all Treasury securities.

If the U.S. starts missing interest or principal payments, borrowers would demand higher and higher rates on new bonds, as they did with Greece, Portugal and other heavily indebted nations. Who wants to keep loaning money to a deadbeat nation that can’t pay its bills?

At some point, the government would have to slash spending in other areas to make room for any further sales of Treasury bills and bonds. That could squeeze payments to federal contractors, and eventually even affect Social Security and other government benefit payments, as well as federal workers’ paychecks.

A default would likely trigger another financial panic like the one in 2008 and plunge an economy still reeling from high joblessness and a battered housing market back into recession. Federal Reserve Chairman Ben Bernanke calls failure to raise the debt limit “a recovery-ending event.” U.S. stock markets would likely tank — devastating roughly half of U.S. households that own stocks, either individually or through 401(k) type retirement programs.

Eventually, the cost of most credit would rise — from business and consumer loans to home mortgages, auto financing and credit cards.

Continued stalemate could also further depress the value of the dollar and challenge the greenback’s status as the world’s prime “reserve currency.”

China and other countries that now hold about 50 percent of all U.S. Treasury securities could start dumping them, further pushing up interest rates and swelling the national debt. It would be a vicious cycle of higher and higher interest rates and more and more debt.

The U.S. has long been the global standard for financial stability and creditworthiness, with Treasury securities seen as a fail-safe investment. But after the near-shutdown of the U.S. government and a new credit-rating report this week questioning the country’s fiscal health, Treasury bills and bonds are losing luster.

If there is a debt limit deadlock, the government by this summer could find itself legally unable to borrow more money to pay its bills, beginning with interest on its debt and gradually extending to day-to-day federal operations. At some point, the government would have to decide which bills to pay and which to put aside.

The debt ceiling will be hit on or around May 16, the Treasury Department says. Unlike the threatened government shutdown, the impact would start slowly, but then build mightily until the damage would be so dire that few political leaders or economists even want to contemplate it. The day of reckoning could likely be delayed at least until early July with creative bookkeeping.

When the House first rejected the Bush administration’s $600-billion bank bailout in September 2008, the Dow Jones industrials went into a dizzying 778-point tailspin. A whiff of a possible similar stock market collapse came on Monday with a sharp selloff on Wall Street when the Standard & Poors lowered its outlook on U.S. debt to “negative” from “stable,” possibly a first step toward a possible downgrade of America’s coveted AAA credit rating.

“We haven’t downgraded it. We just said, if nothing happens, we may have to,” said S&P chief economist David Wyss. He said a government default remains uncharted territory, “which is one reason why it’s not a good idea to hit the debt ceiling.”

“There’s reason to worry,” said Wyss. “But my best guess is that we sort of muddle through this. Cuts will be made, they’ll be too little too late, but at least they will be enough to maintain a triple-A rating.”

“It’s another game of chicken. And this time there are Mack trucks going at each other, not bumper cars. This is a biggie,” said American University political scientist James Thurber. But he predicted that, as in the past, “there will be an accommodation. They will avoid a crash.”

Investment bank J.P. Morgan Chase recently concluded that any delay in making an interest or principal payments by the Treasury “even for a very short period of time” would have large “long-term adverse consequences for Treasury finances and the U.S. economy.” The analysis is being circulated on Capitol Hill by supporters of raising the debt limit.

“If anyone wants to push that button, which I think would be catastrophic and unpredictable, I think they’re crazy,” JP Morgan CEO Jaime Dimon said recently of those seeking to block raising the debt limit.

House Speaker John Boehner and most other GOP leaders agree on the need to raise the debt limit — and don’t want to be held responsible for a new financial meltdown. Still, they want Obama to make more concessions on spending cuts than he has done thus far. That isn’t sitting well with liberal Democrats, who think Obama has already given too much ground.

One reason the two parties can’t find common ground: they can’t even agree on what’s causing high deficits. Democrats mostly blame it on policies of George W. Bush: two wars, tax cuts that continue to benefit the wealthy and an expensive prescription drug program. Republicans see government spending as the culprit, particularly on Obama’s watch.

In fact, the main reason is the deep recession, which slashed tax revenues and led to hundreds of billions of dollars in recession-fighting spending by both Bush and Obama. The debt was $9 trillion in late 2007 before the start of the Great Recession, and it’s just a sliver under the $14.3 trillion limit today.

Even though GOP leaders say they want to avoid more economic chaos, there is a large crop of tea-party aligned Republicans threatening to refuse to raise the cap under almost any circumstance. Polls suggest a large percentage of Americans oppose raising the debt limit.

The debt limit has been raised ten times over the past decade. Obama voted against Bush’s debt-limit increase in 2006 as a senator, accusing Bush of “a leadership failure.” Obama recently apologized for “making what is a political vote as opposed to doing what was important for the country.”

Copyright © 2011 The Associated Press

29 Responses to Default could destroy U.S. economy

  1. Michael Griffith aka Griff

    April 24, 2011 at 7:27 pm

    The exact quote…

    “The fact that we are here today to debate raising America’s debt limit is a sign of leadership failure. Leadership means that ‘the buck stops here.’ Instead, Washington is shifting the burden of bad choices today onto the backs of our children and grandchildren. America has a debt problem and a failure of leadership. Americans deserve better. I therefore intend to oppose the effort to increase America’s debt limit.” – The Honorable Barack Obama, 2006

    So Obama was against soaring deficits (Bush’s deficit spending, by the way, pales in comparison to Obama’s and the Democrats’) and yearly debt limit increases before he was for them. And now he claims that it was a “political” vote? Do senators cast a vote for any other reason?

    And now “bad” choices are “good” choices. Bad wars are now good wars. Bad policies are now good policies. Leadership failures are now leadership successes.

    And apparently, we Americans no longer deserve better. Our children and grandchildren will thank you, Barry, for all you’ve done to unburden them.

  2. Jon

    April 24, 2011 at 8:03 pm

    “The U.S. has long been the global standard for financial stability and creditworthiness”

    Not since 1981, and the implementation of Reaganomics. “Deficits Don’t Matter”. “It’ll Trickle Down”. “The Laffer Curve”. Uh-huh.

    J.

    PS – Griff? Wouldn’t you say that some of the “bad choices” were the monstrous tax cuts benefiting only a wealthy few are at least part of the problem?

    By the way, “(Bush’s deficit spending, by the way, pales in comparison to Obama’s and the Democrats’)”? Um, what? No, it doesn’t. Even with Reagan-era tax rates, by the end of his 2nd term President Clinton ran a surplus. What happened to that?

    To go further back, Jimmy Carter ran a small deficit. Ronald Reagan? Rather a lot more.

    Well well well…

    Finally, if you want to blame that on Congress, feel free. Just don’t blame the President for all the failures and Congress for all the successes.

    J.

    • Almandine

      April 24, 2011 at 8:47 pm

      You know, Jon… you don’t know Jack.

      Should you ever come into today – leaving Truman, JFK, Carter, Reagan, Clinton, Bush, et al in the past and actually look at the CURRENT situation, the current state of our Union, your game would fall apart. There are NO MORE POLITICS that will float our boat. It’s all about realtity NOW, not in the past.

      But then, it doesn’t matter, your view… it’s all so uninformed.

      • Michael Griffith aka Griff

        April 24, 2011 at 9:17 pm

        I believe it was Nixon that said some thing to the effect…We’re all Keynesians now.

        • Almandine

          April 24, 2011 at 9:22 pm

          I’m not… nor are you.

      • Doug Thompson

        April 24, 2011 at 9:31 pm

        Almandine. Put a cork in the attacks on other posters.

        • Almandine

          April 25, 2011 at 1:03 pm

          Yes, yes, apologies to Jon… exasperated in the moment by the lack reality, the simplistic reliance on ideological bias, and the appeal to “snapshot” moments in history, when the accumulating facts of today describe a predicament so different from those of the past. One must only search the web for long term historical data on spending vs GDP, revenue vs GDP, debt and deficit vs GDP… and – when compared analytically – it all becomes clear vis-a-vis the basis of our fiscal plight.

          Current revenues are about 30% of GDP – down somewhat over the last couple of years, but current spending is about 40% of GDP – the highest amount by far – and the only period in history – that such a percentage of GDP has ever been spent (minus WWII). The facts dovetail to show our current fiscal trajectory is unsustainable. The federal govt borrows 43 cents of every dollar spent… which indicates that to merely break even, spending would need to be reduced by that amount – or alternatively, revenues would have to increase by 76%. Neither seem likely to happen.

          Clearly, the “tax cuts” did not reduce revenues by that amount, and any claim that reinstatment of pre-Bush tax rates would solve the problem is preposterous. Had the Congress, and now the current administration, not been hell bent on increasing total US spending exhorbitantly since the Dems took control in 2006, the budget would be close to being balanced and the debt load would not be near as big or matter near as much. The meltdown in 2008 might also have not become reality.

          Spending this year will be a full 1/3 more than in 2006… and the projections for the future are astounding. No amount of revenue enhancement will be enough, and any belief that we can continue as we are currently doing by “raising taxes on the rich” is to live in a fool’s paradise.

          The breadth and depth of our economic history and health are readily available: http://www.usgovernmentspending.com/spending_history

          • bmclellan

            April 25, 2011 at 2:34 pm

            Hey Al, as long as they are playing with fiat monies anyway why don’t they print up a trillion and inject it into small business sectors like textiles, machine works, and tool and die ?

            Earmark it so anyone with a net worth over 1 mil can’t touch it and see if a peoples central bank willing to give loans and fair interest rates where deserved will float.

            Seems to me it would relieve some of the pressure in the form of a new tax base. That way the uber rich who just can’t find a way to reinvest in America would have some competition for once.
            Yes I am not an economist, but,
            Am I insane ?????

            • Almandine

              April 25, 2011 at 3:47 pm

              Hi Bryan… Happy Monday.

              It seems to me that your plan could work… but the regulation and favoritism that would be necessarily [politically] inherent in such a scheme would hamstring potential success. Should we look at similar support of small businesses in today’s govt-sponsored funding schemes, we see programs to favor racial minorities, women, and native Americans, for just a start, and while they are often successful, there is often the “power behind the throne” – i.e., Big Money, which is the actual player. Sure, these “set-asides” force the successful advancement of lesser entities – the public face of businesses – within the economic system, but they don’t really spawn multiple independent start-ups that would create the robust growth needed to build the greater economy. Forming “peoples” banks with govt money would not actually help much with regard to greater diversity of funding the “deserving”, the analog of which is what actually landed us in the subprime mortgage mess.

              I think a better plan would be to promote the use of private funds for such an enterprise, including the Big Money players, i.e., those who could gain exponentially from an expanding industrial base. A look back in history shows that that was how the industrial revolution – built upon entrepreneurial risk-taking and chutzpah – led us from agrarian society to consumerism. Better mousetraps all along the way… rewarding creativity and industriousness.

              I recognize there will be two problems with that approach, though: 1) Freeing up the market to allow true Capitalism to meet the wants and needs of society means that the heavy regulatory hand of govt must be amputated to: a) allow such a market to exist, and b) keep away from picking winners and losers, and 2) The resulting perception that all those monied suckers who fund the free enterprise are raping the poor folks and making too much profit. These problems, though, could be dealt with by reigning in the Crony Capitalists via genuine application of the justice system, re-establishing the systemic ethics and morals that people would need to believe in to function honestly and cooperatively on an individual basis. A TALL ORDER, no doubt.

              Of course, that is the basis and goal of Capitalism… to create a free market system that provides for the well-being of both sellers and consumers, the degree of which being indicated by market success, i.e, satisifed sellers and consumers. No centrally-planned economic system will ever achieve that.

              • bmclellan

                April 25, 2011 at 4:44 pm

                Thanks Al, guess I’ll keep the lantern lit long as the fuel holds out..
                Sick and tired of the word hope I are..

                • Almandine

                  April 26, 2011 at 9:13 am

                  Good plan. None of the 3 branches of federal govt – nor the 59% of Americans who get checks from the govt – are interested in eliminating the crony capitalists. Sans that, we’re done.

    • Michael Griffith aka Griff

      April 24, 2011 at 8:59 pm

      Monstrous tax cuts? That is such a ridiculous argument I won’t waste my time on such partisan blather. But I would ask, will restoring those tax cuts cover the 1.6 trillion dollars we’re adding to the deficit this year alone, not to mention the 14-plus trillion already on the books, or the 113 trillion in other unfunded liabilities (Medicare, Medicaid, Social Security) in the future?

      Do you really think rasing taxes on the “rich” will cover this shortfall?

      Clinton’s budget surplus was a result of looting Social Security and creative bookkeeping. One look at the debt figures through the nineties shows a consistent upward trend of the national debt. Where did the phantom surplus go? Clinton added almost 2 trillion to the national debt during his eight years as president.

      Besides, how do you argue my comparison to Bush’s deficit spending to Obama’s by using Clinton’s phantom surplus? And going back to Carter and Reagan as a yardstick for today means nothing. The national debt has been on a steady and unceasing rise since after WWII. Each president has increased the debt in one form or another.

      Obama has made the biggest leap of them all.

      The indisputable fact remains that in little over two years as president, Obama has already nearly equalled Bush’s deficit spending through eight years. Um, and by the way, when Bush took office in 2001, our national debt stood at 5.727 trillion dollars.

      But I will give credit where credit is due, and break down the actual Treasury numbers by who controlled the Congress…

      Bush’s first six years with a Republican Congress – 2.95 trillion (rounded) added, for an average yearly increase in debt of 491 billion dollars.

      Bush’s last two years with a Democrat Congress – 1.95 trillion (rounded) added, for an average yearly increase in debt of 975 billion. The Democrats nearly doubled the budget deficit for the last two years of Bush’s term.

      Obama’s first two years with a Democrat Congress – 3.46 trillion (rounded) added, for an average yearly increase in debt of 1.73 trillion dollars. That’s nearly four times the average deficit spending by Bush and the Republicans.

      Those figures only include up to the anniversary of Obama’s inauguration. The last three months has seen an increase in the national debt of an additional 260 billion dollars.

      I’m no fan of either party, but the numbers don’t lie. The Democrats spend far more than Republicans do. And each and every year, regardless of the party in power, our national debt rises steadily.

  3. Jon

    April 25, 2011 at 1:47 am

    “Monstrous tax cuts? That is such a ridiculous argument I won’t waste my time on such partisan blather. But I would ask, will restoring those tax cuts cover the 1.6 trillion dollars we’re adding to the deficit this year alone, not to mention the 14-plus trillion already on the books, or the 113 trillion in other unfunded liabilities (Medicare, Medicaid, Social Security) in the future?”

    Yes. It would.

    I see no reason to quote anything else.

    J.

    • Michael Griffith aka Griff

      April 25, 2011 at 7:23 am

      Hahaha. Okay.

    • Michael Griffith aka Griff

      April 25, 2011 at 8:08 pm

      By the way, would you credit Clinton for his “surplus” or would you credit the Republican Congress at the time? Just curious.

  4. bogofree

    April 25, 2011 at 3:35 pm

    Just some typical playbook talking points from Democrats Are Us and the defenders of President WOW (Walk On Water). Bipartisan blather that you see from both sides which explains why so many have the “I” next to their name on the voting ledgers.

    The economy fluctuates and some presidents are fortunate enough to be on an uptick and some less fortunate and on the downside. As HST said “Give me a one armed economist since they are always saying on the other hand….”

    As far as taxes it is more of the traditional party line blather of “soak the rich” since their big crime is to actually make money. I’m in the upper 10% and retired and am personally quite tired of financing an alternative life style for others which I have done for decades. Whenever a few bucks are needed just drag out the class warfare card. Might as well play to your voting block since a good portion of the Republicans do so with promised tax cuts.

    I’m just amazed at the number of employees – I will not use workers – that are on the government tit and with benefits that are in excess of those worker bees in the DPS (Dreaded Private Sector). IMO there is enough revenue the problem is how it is distributed.

    • Michael Griffith aka Griff

      April 25, 2011 at 4:59 pm

      Unfortunately those “i’s” are the free-thinkers most responsible for this power-swapping scheme. They swing elections back and forth between the two parties. They should really change that classification to “Undecided as of yet, I need more lies in order to make an uneducated choice.”

    • Jon

      April 26, 2011 at 1:56 am

      From the perspective of one of those in the “top 10%”, I would like to point out one more reason for supporting basic humanity in those less fortunate, less intelligent, and less motivated than you.

      Your comfortable and pleasant retirement is sorta predicated on the minor detail that the mob won’t storm your castle. The police might be on your side until they realize they too are not part of your caste, and then things might get warm for you, your children, &c.

      So pass out some of your wealth The happier you keep them, the less likely they are to riot.

      Thank you for letting me let off a little cynicism.

      Finally, basic humanity. If you have the means to provide for people to have a place to live, food to eat, and enough support to have a little human dignity and you deny it to them, you are not worthy of being called a human being.

      J.

  5. bogofree

    April 25, 2011 at 5:11 pm

    I am an “I” who will not vote for national office. None. Finished. No more. The bailout of 2008 was the final sham. I still vote in every election and always have but now if it is just for national office I will get my ballot and return it blank. I have not seen anything on the presidential stage that would restore any faith. Wonder how many blanks will start to proliferate?

    • Michael Griffith aka Griff

      April 25, 2011 at 8:07 pm

      I have a better idea. Vote Libertarian. Vote Green. Vote Space Alien. But vote nonetheless.

      If all those “independents” would start thinking and voting independently we may actually make some kind of difference.

  6. bogofree

    April 25, 2011 at 8:16 pm

    Spaces alien? Why would I vote for Palin? Well…maybe she does have a real birth certificate.

    • Michael Griffith aka Griff

      April 25, 2011 at 9:22 pm

      Ha. Aliens are far too advanced to bother with such antiquated means of identification. They’ve all been VeriChipped!

  7. woody188

    April 25, 2011 at 9:42 pm

    It’s down to less pain if done now, or more pain if it’s put off until later. Let’s take our lumps, start the Year of Jubilee and forgive all debts.

    • woody188

      April 25, 2011 at 10:22 pm

      Of course we could also argue that the U.S. economy is already destroyed. A default might save what is left from being shipped overseas. If our dollar is worthless, we won’t be importing products manufactured elsewhere. They will be too expensive for us to purchase.

      • Michael Griffith aka Griff

        April 25, 2011 at 11:32 pm

        No one cares Woody. No one believes some thing like a total collapse can happen here. This is America – we’re special, immune to such trivialities. Just print more money.

  8. bogofree

    April 26, 2011 at 9:02 am

    Pass out to those less fortunate? Ah…my taxes and various failed political schemes were suppose to address that. Also you have no idea or comprehension of what I give back to the community. Another judgment call?

    Giving should be and have been done by me locally and not by writing a check. I also realize that a certain segment of the “basic humanity” you ramble on about have “earned” this perceived “right” by contributing what to our society?

    Storming the castle? You have been reading too much apocalyptic science fiction. So we are suppose to bribe them? I thought that was already done with Section 8, food stamps, Medicare, clothing allowances and on and on. I don’t mind helping but I do mind being taken as a cash cow sucker.

  9. Jon

    April 27, 2011 at 11:44 pm

    If it didn’t work, talk to your elected representative. Just because it has been diverted into corporate welfare and endless paperwork hassle to ensure it doesn’t go to fund an abortion doesn’t mean it should not be done.

    No, I have no idea what you’ve given back to the community. But given that you yourself claimed to have more money than 90% of them, I’d say they gave you more money than you gave them. There’s a judgment call for you.

  10. bogofree

    April 28, 2011 at 8:20 am

    I happened to have earned my money by actually using a combination of hard work, education and smart investing. Try that instead on the perpetual whine about those who are successful have an endless and bottomless obligation to provide for those who wish (LOL) “To storm the castle.” I just love the moonbats continual attempt at some type of bizarre guilt trip being hoisted on “The Rich.” Nothing like a shallow attempt at emotional blackmail and an attempt to pass off your own personal failures by blaming others. Sad.

    It hasn’t worked for decades and have actually gotten worse. Maybe voting for elected representatives is the problem?

    My wife and I both did it while being in the public sector. We invested in those companies that received all that corporate welfare just like most of us do. Try it. Then you can join “The Rich” and toss greenbacks around to the downtrodden.

    • Almandine

      April 28, 2011 at 8:57 am

      It just doesn’t click with these guys, does it? Anybody who gets ahead must have had it “given” to them, because that’s the only way a person get anything.

      Wonder if Jon still lives at home with Mom… at age 50?