Why the U.S. Debt Ceiling Debate is a Bigger Deal than the Fiscal Cliff

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With the fiscal cliff deal behind us at last, the next big battle in Washington will focus on the U.S. debt ceiling, and the stakes are high.

The United States officially hit the $16.394 trillion U.S. debt ceiling Dec. 31. The debt now stands at about 73% of U.S. gross domestic product and will continue to rise over the next decade without major spending reforms.

Now the U.S. Treasury Department has decided to employ what Treasury Secretary Timothy F. Geithner calls "extraordinary measures" in the next two months to avoid actually defaulting on debt. Those measures include temporarily stopping the reinvestment of federal employees' retirement account contributions into short-term government bonds as well as other steps to discontinue debt issuance.

The new deadline for resolving the debt ceiling issue looms at the end of February, giving Congress little time to regroup after partly resolving the fiscal cliff.

"Do not forget that the fiscal cliff is only one of three upcoming problems in our ongoing fiscal madness," Money Morning Chief Investment Strategist Keith Fitz-Gerald said. "There's still the debt ceiling, sequestration and the complete lack of a budget to contend with. In other words, it's on to the next crisis now."

Dangers in Hitting the U.S. Debt Ceiling

The last time the country approached the U.S. debt ceiling, in 2011, it came close to defaulting on its debt and had its AAA credit rating stripped by Standard & Poor's for the first time ever.

S&P at the time said "political brinksmanship" in the debt ceiling debate had made the U.S. government's ability to manage its finances "less stable, less effective and less predictable."

The previous budget battle actually led to an agreement to impose across-the-board spending cuts, known as "sequestration," on Jan. 1, 2013, as well as implement tax increases – together known as the fiscal cliff.

If no U.S. debt ceiling deal is reached this time, the country will most likely receive credit rating downgrades from multiple rating agencies, sending equity markets into a tailspin and the economy back into a recession.

If the country defaults, a very real possibility, it would essentially have to choose what expenses and debts to pay and which can wait. The Treasury's inability to make some payments could cripple the global banking system, which has a huge stake in U.S. assets and the dollar.

A default would also delay or stop Social Security and unemployment benefits as well as military service members' checks, and unemployment and inflation would rise.

The Heated U.S. Debt Ceiling Debate

In 2011, when the country was on the brink of default, the debt limit was raised after U.S. President Barack Obama agreed to $1 trillion in immediate spending cuts and another $1.2 trillion in cuts set to kick in this year.

This time, the president has made clear he does not want to engage in any more political brinksmanship over the debt ceiling.

"While I will negotiate over many things, I will not have another debate with this Congress about whether or not they should pay the bills they have already racked up," President Obama said in remarks at the White House.

This time, Republicans want debt limit increases to be matched dollar-for-dollar with spending cuts, while President Obama and fellow Democrats insist on implementing both spending cuts and tax hikes.

"If Congress refuses to give the United States government the ability to pay these bills on time, the consequences for the entire global economy would be catastrophic – far worse than the impact of a fiscal cliff," Obama said.

Yet Republicans now appear more ready than ever to push the country into default and accept the consequences.

"Our opportunity here is on the debt ceiling," Sen. Pat Toomey, R-PA, said on MSNBC, adding Republicans would have the political leverage against Obama in that debate. "We Republicans need to be willing to tolerate a temporary, partial government shutdown, which is what that could mean."

Republicans are hopeful they can use the debt ceiling as leverage to force President Obama and fellow Democrats to accept major spending cuts to entitlement programs such as Medicare and Social Security.

"Without meaningful reform of entitlements, real spending controls, and a fairer, cleaner tax code, our debt will continue to grow, and our economy will continue to stumble," House Speaker John Boehner, R-Ohio, said in a statement after the House vote on the fiscal cliff deal.

What's the Likely Outcome?

The easiest resolution and perhaps likeliest scenario to end the debt ceiling debate is to simply raise the limit, which has been done 75 times since 1962.

That would postpone the chance of the U.S. defaulting on its debt and may prevent another downgrade, but do nothing to solve the issues at the core of the nation's fiscal problems.

If Congress can do more than just kick the can down the road again, a deal might be passed that raises the debt limit, tackles some of the automatic spending cuts and makes minor adjustments to entitlement programs.

And the best outcome, but least likely, given the actions of Congress over the past two years, is that along with raising the debt limit, major spending cuts in defense and other programs are enacted, as well as reforms to Medicare, Medicaid and Social Security.

Ultimately, the U.S. debt ceiling will have to be raised, and both Republicans and Democrats know this, but it's unclear whether they'll reach any compromise, and even if they do, it might not prevent another credit rating downgrade.

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Join the conversation. Click here to jump to comments…

  1. PaulD | January 4, 2013

    There will be no negotiation on the debt ceiling.
    Why?
    Because Obama doesn't need to.
    Why?
    Because a lot of the debts that we have to pay were run up by the McConnells and Boehners of this world. The two wars that he didn't feel the need to pay for. The prescription drug benefit they thought was okay to borrow from the next few generations without any plan to pay back. Hell, there's still bonds that were issued in Reagan's second term that have to be paid for.

    The American people now know from last year that the debt ceiling is not about borrowing more money to spend. It is about appropriating money to pay for that which has already been agreed to and signed sealed and delivered by Congress and the President. Many Congresses and many Presidents. The full faith and credit of the USA. And even McConnell and Boehner can't blame all that on this particular President.

    So if Republicans wants a fight on this, and if they push it to the brink again, the country will know whom to blame for the fallout. It's entirely possible that they could not only severely damage the economy of the world in their effort but also destroy themselves as a serious political party, consigning themselves to the permanent far right irrelevance they appear to relish.

  2. H. Craig Bradley | January 5, 2013

    THE HOUSE: A FAILURE TO COMMUNICATE

    The big mistake House Republicans have made is to not first communicate to the people in understandable terms WHY the present fiscal course (Obama's) is unsustainable and disruptive. Most people don't follow "politics" and don't care how much debt we have. Americans are used to living beyond our means with credit at ALL levels, so its ingrained and cultural.

    The Republicans have not changed anyone's views on the subject of debt and spending, hence they can not depend on any public support for a government shutdown. In contrast, after having won reelection, the President thinks he does have the general public's support. Remember too, when then Speaker Newt Gingrich orchastrated a government shutdown in the 1990's it backfired on them while President Clinton remained popular. Republicans do not have the wide spread good will to use their leverage without losing the political battle. Obama knows he has the public behind him, or at least not against him.

    In the end none of this matters because we are already past the point of no return anyway. We must continue to borrow even more money just to pay the interest on the money we already borrowed in past years. So, failure is inevitible now and no politican can change the course. All President Obama has done with $1 Trillion dollar annual deficits in the last four years is accelerate the day we have a complete financial collapse and resulting chaos. Bad choices all along, America!

  3. Frank B. | January 6, 2013

    It doesn't matter, obummer will just issue an executive order to raise the limit.
    It's what he does. Congress has capitulated it's control of the nations purse-strings.

    Keep your powder dry and your pantry well stocked… the sh*t will be hitting the fan shortly!

    • bev | April 9, 2013

      Hey, "Frank B"? I guess you are clueless about how many times the "limit has been raised" before by many of our past presidents. i suggest you do your research, first!

  4. G Roberts | January 7, 2013

    I believe we have past a point where it's always about a fight — na, na, na — you did this and now we have our toy and we are going to do this – na, na, na. When do leaders stand up and lead? When do they look at history and say, "Oh, this is how we got into this mess, I must find a way out."

    When does the President grow up, or does he? I was listening to Donald Trump say how bad the Congress was and all they had to do was – "this," and Obama would cave. Certainly Donald doesn't believe that — Obama won't cave because he is still in the na, na, na, thinking — he's still lost in his thoughts that he is smart, and he is in charge. In the end he won't seem so smart — he'll be on the same end that Bush found himself — then what will history report?

    No, looking in the rear view mirror and steering the world in the same direction while saying, "How great thou art," won't work either. We need leadership not beat'r-ship.

    To propagate foolishness is easy — it doesn't make them smart, it doesn't show their intelligence. If Obama was as smart as he thinks he is he'd be showing us what he can do rather than adding an increase of over 55% to the Current Account Debt in less than 4 years. He's added a trillion dollars more to the debt in four years than Bush did in eight years. How smart is that? How does the US Pay that? Where to they borrow from now? We're down to the piggy bank with pennies in it and a knife to get them out — so, what next? Are we going to blame Bush for what Obama has done?

    Yes, the so called intelligent people will just keep blaming Bush — na, na, na, — see he did it, Bush did it.

  5. Andy | January 8, 2013

    With Republicans against more unrestrained deficit spending and the President saying publicly that he is against debating the debt ceiling increase and placing the full faith of the US government’s credit at risk, we can expect another round of political theatrics over the next few weeks. Fun times indeed as we lurch from one crisis to another.

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