You will probably see headlines this morning that suggest Speaker Boehner is risking financial disaster for the U. S. by taking the country to the brink of default. Is that true? Well, not quite. But, before we can see what the real problem is here, we have to venture into the land of debt, deficits, spending, taxes, and bond principal and interest payments, sort of Public Finance 101.
Speaker Boehner negotiates with President Obama and his fellow Dems
Speaker Boehner said in New York last night that he will agree to raise the debt limit by X dollars only if Democrats will agree to cut spending by X + 1 dollars. Since President Obama wants a debt limit increase of two trillion dollars, Boehner is looking for guaranteed cuts in federal spending of more than two trillion dollars. It is likely that the time period for scoring or assessing the cuts would be from five to ten years. The Democratic response appears to be one of looking, instead, for revenue increases, i.e., closing "tax loopholes," for disfavored constituencies, e.g., oil companies, as opposed to cutting spending by two trillion dollars.
Debt limits, spending cuts and the timing issue
To understand what is happening here, remember that the debt limit is the cumulative amount of money that the federal government can borrow from the public. The limit currently is about 14.2 trillion dollars, and the federal government is on pace to exceed that limitation in about one week, unless the Feds cut their rate of spending or increase revenue. However, Treasury Secretary Geithner has said he could juggle balances, books or whatever to get the country to August, 2011, if he had to, without any increase in borrowing, tax revenue or cuts in spending.
The U. S., like any debtor, has to have sufficient funds to pay interest and principal on its bonds, as those payments become due, or it will default. Essentially, raising the debt limit allows the government to meet its payment obligations by issuing or selling more bonds to the public, which gives it more revenue. Of course, cutting spending, would also give it more funds to meet its bond obligations. Boehner's demand for spending cuts equal to or greater than the debt limit extension may sound like he is saying "we'll agree to issuing more debt, but we won't need to because the cuts in spending will free up funds for debt repayment." But that is not true because of the timing issue.
Deficits and debt limits
The U. S. Government has a projected deficit of about 1.5 trillion dollars over the next year. That means that without any change in projected revenue or spending, the Feds will need to borrow about two trillion dollars over 16 months and therefore need another debt limit increase in about 16 months (assuming it gets a two trillion increase now). If Speaker Boehner's 2 trillion dollar spending cuts are spread out over five years, the spending cuts will extend the time for another debt limit increase to about 20 months, rather than 16 months. (The most recent debt limit extension was about 15 months ago).
The sky in not falling: no U. S. default on the Horizon
Thus, the Tea Party may not be too thrilled with only two trillion dollars cut in five years. Perhaps they will want to see four trillion dollars in spending cuts. On the other hand, Speaker Boehner can argue that he said cuts that exceed that debt limit extension, and that in any case this is only a start in a process of negotiating spending cuts in exchange for raising the debt limit.
In any case, the Democrats will see the political benefits in negotiating some level of guaranteed spending cuts--and some level will be agreed to by the Republicans, so there will be be an extension of the debt limit. If that extension is not this week, it surely will be done in time to avoid a default on U. S. bond payments. So, once again, the sky is not falling, the U. S. will not default and the dollar might even recover some of its value over the next year, assuming Fed Chief Bernanke gets a handle on monetary policy--but that's another post.