What’s the deal with the debt crisis talks? Congress cut an 11th hour deal before the August 2nd deadline.
So, everything’s kosher now, right? We got a deal done in time and the government is solvent. For now. The debt ceiling was raised and Tim Geithner was a happy clam. We went to bed thinking that everything was fine in our little kingdom.
We woke up and saw headlines tossing some noise our way about downgrading U.S. credit. All this talk is such a buzzkill, isn’t it? We’ve gone from celebrating a compromise and a narrowly averting a crisis to…what? Being in crisis mode again? Didn’t our truculent members of Congress manage to put aside their posturing and compromise on a deal that supposedly saved our nation from an economic crisis?
My opinion of Congress aside, let’s get to the crux of the issue—what’s the problem now?
First: what is the Debt Ceiling?
The Debt Ceiling is the limit that Congress allows the Treasury to owe to lenders. The U.S. borrows money from other countries, large banks, and bondholders to cover what we need to pay when the government doesn’t have enough revenue from taxes, income from participation in the markets, and fines.
The other option to borrowing money is to print more money—but that leads to inflation. The 1970s demonstrated that a stagnant economy combined with inflation only serves to further cripple the economy.
Breaking it down:
Congress decides that the United States must spend X amount of money. Some examples of spending include: defense, Social Security, Medicare, paychecks for Members of Congress, debt and interest repayments to lenders, and so on.
The United States government gets its money from taxes, bonds, income from participation in the markets, borrowing money, inflation by printing more money, and collecting fines.
But the United States Treasury doesn’t collect enough revenue to pay all the bills that Congress orders the government to pay.
When the government doesn’t have enough money to pay for everything, it borrows money via the U.S. Treasury by selling bonds or borrowing from other nations and large financial institutions.
Congress decides how much money the government can borrow through the Treasury thus establishing a debt ceiling. This is a ceiling established by Congress to ensure that the Treasury’s power is limited.
The U.S. Treasury cannot borrow money beyond the debt ceiling assigned by Congress.
We would have reached the debt ceiling on August 2, 2011 if Congress did not raise the debt ceiling.
Thus making the government unable to pay all the bills we have to pay and not being able to pay our creditors.
We raised the debt ceiling so why was our credit downgraded?
Congress cut back on spending- but not enough. The United States owes a lot of money and spends a lot of money—but due to projected increases in spending: especially on Social Security and Medicare with an aging population and earning less revenue due to tax cuts and a sluggish economy, creditors think the U.S. isn’t as good a credit risk it used to be. The United States is going to max out our debt ceiling again—and far too soon—because the government just doesn’t make enough money to cover all of our bills and debts. Until our economy improves and we increase revenue, creditors think we’re a good but not an excellent credit risk.
What would fix this?
Spend Less. This means cutting programs like Social Security, Medicare, Pell Grants, which Democrats don’t want to do. Spending less on defense and homeland security, which Republicans don’t want to do. Refusal to significantly reduce spending tells creditors that the U.S. isn’t serious about managing its debt or maintaining a healthy financial outlook.
Earn More. This means eliminating certain tax cuts- especially the Bush tax cuts and increasing taxes overall, which Republicans don’t want to do. The refusal to increase tax revenues also tells creditors that the U.S. isn’t serious about paying off its debts and bills.
What does the U.S. credit downgrade mean for the average consumer?
How does the U.S. credit rating affect the individual consumer—the average Joes and Janes like you? This has never happened before and it’s hard to predict what will actually happen but here is an outline of what might come as a consequence of this downgrade.
Interest rates could be increased for loans such as car loans, mortgages, credit cards, and student loans.
If you were shopping for a new car or a new house, interest rates might be higher.
In the long run, anything you buy—a new car, a new house, whatnot—is going to cost you more.
That means people are going to decide that maybe they can just live with their old car just a while longer, or keep renting, or what not. Fewer people buying new cars, new homes, new toys/gadgets, etc means less consumption (buying) which then hurts our economy.
Less consumption means less tax revenue to the government via sales tax, corporate/business taxes, and so on. This further limits the government’s revenue.
Less consumption also means companies will have to downsize because they just don’t need as many workers- since nobody’s buying the things they’re making. Which leads to less revenue for the government via its participation in the market and less revenue from taxes. Fewer jobs mean higher unemployment rates.
Higher interest rates also means companies that owe money or need to borrow money to expand or stay in business won’t have the money to do so and won’t hire more workers—or keep the workers they do have.
The more we spend on interest, the less consumption there is. The less spending there is means less money going into the economy—to fund jobs and allow businesses to expand.
Which is bad news for people looking for jobs.
This holds potential for layoffs and erasing any economic recovery we’ve experienced since the original recession began in 2008. Even if our economy recovers, we just aren’t growing as fast as we used to and we simply don’t produce as much money.
We also face a possibility of higher tax rates. Spending more on taxes means less consumption as well.
There’s a possibility of inflation too, which means that if you’ve been saving for retirement- you’re going to have to start saving more than you did before.
Due to inflation, if it happens, the cost of living is going to get even higher while our paychecks stay flat due to a stagnant economy.
Some estimate that just a half a percent increase in our interest rate could result in the loss of hundreds of thousands of jobs in this economy.
Not all doom and gloom
The picture painted here is pretty dark and gloomy but it could be worse.
Only one rating agency, Standard & Poor, has cut our rating. The other two major rating agencies: Moody’s and Fitch haven’t downgraded our AAA rating although they’ve assigned a negative outlook. They think the outlook isn’t great—we’re spending more than we earn and the outlook for our earnings isn’t bright but they think we can still fix things before the situation goes really south.
My personal $0.02:
All right, people- so the above was just an aggregate of various news pieces and talking heads on TV—but as an historian, here’s one thing to consider: clearly we have neglected the lessons of history.
- Our Economy, as almighty as it is, cannot fund foreign conflict and expand social programs or cut tax revenue at the same time. This lesson was a painful lesson we learned during the Vietnam War- we spent billions waging war in Southeast Asia while spending billions on the Great Society (Head Start, Medicare, VISTA, etc). What happened was that our economy got clobbered. Our economy didn’t grow but we were hit with skyrocketing inflation and got buried in a major recession in the 1970s that took a long time to recover from. The Great Society didn’t achieve as much as legislators had hoped and our mission in Vietnam was essentially a failure while we wasted billions and crippled our economy. When 2003 rolled around, we thought it was a brilliant idea to fund two expensive wars in Afghanistan and Iraq AND issue the Bush tax cuts. Brilliant move, Congress. Brilliant.
- Yes, I know some defend Congress saying we didn’t think this war was going to take this long or be this expensive. They [Afganistan and Iraq] are technologically backward—just two middling little backwater desert countries. We didn’t think we’d be there more than, what, a few months? Here’s a little reminder. We said the same thing about Vietnam. A little backwater Asian country—technologically backward, not too many people. How hard could it be to win this war? Well, we were there from 1954 until 1973 and we left with our tails tucked in between our legs—and we didn’t achieve our objective. Instead, we were saddled with a crippled economy, the Great Society didn’t accomplish what it set out to achieve, and an embarrassing blow to the perception of our military might. Congress—next time we decide to wage war—let’s not assume how much it’s going to cost or how long it’s going to take—and hold off on tax cuts and increasing spending on social programs. Another option? Skip the war altogether.
- For those who suggest we eliminate Social Security and Unemployment Insurance, here’s a little tidbit about Social Security and Unemployment and the role they play in our economy. They aren’t just handouts.
Social Security and Unemployment Insurance serve an important role in maintaining a minimum of economic activity. When the cost of living increased and we experienced inflation, the smart thing to do would have been to continue cost of living adjustments for Social Security, extend unemployment benefits, and maintain a ‘baseline’ of consumption on pace with the needs of our economy.
Social Security and Unemployment Insurance play an important role in our economy and we shouldn’t be hasty about eliminating or limiting those programs.
ABOUT OCTAVIAN ROBINSON
Octavian Robinson graduated from Gallaudet University and is currently a Ph.D candidate at Ohio State University. He lives in California with his Weimaraner.