High Noon at the D.C. Corral: The Debt Ceiling Showdown

 

Takeaway

  • McCombs accounting professor thinks debt ceiling should be eliminated, because "it makes no sense whatsoever."
  • The previous debt ceiling standoff, in July 2011, put a drag on the economic recovery.
  • Consequences of paying federal debt with new money could be inflation, currency wars, and the next stock market bubble.

In January, America found itself in the middle of yet another High Noon standoff over the national debt. Once again, the U.S. Treasury hit the limit on what it can legally borrow, and once again, Congress staged a showdown over increasing that limit. This time around, Congress voted to suspend the ceiling for only a few months, setting up another potential standoff for early summer.

Michael Granof has a different idea for how to handle the debt ceiling. “Eliminate it,” says the accounting professor at the McCombs School of Business. “It makes no sense whatsoever.”

Granof knows a thing or two about how Uncle Sam keeps his books. He helps to set the rules, as a member of the Federal Accounting Standards Advisory Board. The root problem with the debt ceiling, he says, is the gap between the time the Congress racks up bills and the time the Treasury borrows money to pay them.

“If you want to control the amount of debt, do that when you pass legislation,” says Granof. “Measures taken by previous Congresses, such as entitlement expenditures, make up a major port of our expenditures today, and they are automatic. They have nothing to do with legislation passed by the current Congress.”

He points to Social Security and Medicare, entitlements which together make up 34 percent of federal spending.

The other trouble with the debt ceiling, says Granof, is that delays in raising it can take a toll on the whole economy.

“You can say that to delay paying bills for a few weeks is not a big deal,” says Granof. “On other hand, the psychological factors could be enormous. Because we don’t know what’s going to happen, people are hesitating to make any sorts of financial commitments.”

McCombs finance professor Lewis Spellman agrees: “When uncertainty is high, the economy is sluggish,” he says.

The previous debt ceiling standoff, in July 2011, did put a drag on the economic recovery:

  • The Dow Jones Industrial Average plummeted 1,864 points in three weeks, and it didn’t fully recover until the following January.
  • For the first time in history, Standard & Poor’s downgraded the government’s credit rating.
  • Ultimately, the standoff will cost taxpayers an extra $19 billion in interest on the national debt, calculates the Bipartisan Policy Center.

During the latest showdown, the Small Business Optimism Index of the National Federation of Independent Businesses dropped to its lowest point in nearly three years. Meanwhile, U.S. corporations are sitting on nearly $2 trillion in cash.

“Businesses are so frightened they won’t do anything,” says Spellman. “Corporations’ accumulated cash on their balance sheets is at a record high, while they’re not spending on investment.”

The deeper problem, he says, is that while Congress haggles over the debt ceiling, it goes right on creating future debt. In January, it postponed planned spending cuts while it made tax cuts permanent. Says Spellman, “Everyone seems resigned to the fact that there will not be fiscal integrity.”

It the short run, he expects the Federal Reserve to go on propping up the national debt by creating new money and buying Treasury bonds. “The question is,” says Spellman, “how long can we keep paying for the federal debt with new money, and what are the consequences?”

Those consequences, he warns, could be inflation, currency wars and the next stock market bubble.

“There is a price to pay,” says Granof. “Like it or not, at some point in the future, we’re going to have to raise taxes, and at same time, make thoughtful cuts in unnecessary expenditures. The debt ceiling doesn’t help us in dealing with any of these. It’s a gimmick.”

Spellman, on the other hand, sees the ceiling as better than nothing – until Congress devises a better way to reconcile the costs of old laws with today’s fiscal limits. “The debt ceiling is a very clumsy way [to accomplish] that,” he says, “but until a budget discipline mechanism is streamlined, that is all we have.”

 

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Faculty in this Article

Lew Spellman

Professor, Department of Finance McCombs School of Business, The University of Texas at Austin

Lewis Spellman received his BBA and MBA from the University of Michigan and his MA and Ph.D. from Stanford University. His research interests include...

Michael Granof

Professor of Accounting McCombs School of Business

Michael Granof received an A.B from Hamilton College, an MBA from Columbia University, and a Ph.D. from the University of Michigan. His research...

About The Author

Steve Brooks

In a quarter-century as a journalist, Steve Brooks has won two Neal awards for excellence in trade reporting and a Press Club of New Orleans award...

Comments

#1 Kris, I enjoyed the LINGO

Kris, I enjoyed the LINGO video! Thanks!

#2 If you're still fuzzy on what

If you're still fuzzy on what exactly the Debt Ceiling is, have a look at our quick animated explanation from LINGO: the language of business. http://www.texasenterprise.utexas.edu/article/debt-ceiling-0

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