Financial armageddon! That’s what we are being told to expect should Congress and the president fail to reach an agreement to raise the debt limit by Tuesday, Aug. 2.
One market trader was quoted as saying that a default on the U.S. government’s debt is an “unthinkable event” that would “make Lehman look like a very small event.” This trader is referring to the announcement in September 2008 when investment bank Lehman Brothers filed for bankruptcy.
The Lehman event is cited by many as the trigger for the final crisis and subsequently deep recession we just experienced. Some politicians and financial commenters agree with this trader, saying a more serious crisis looms Aug. 2, when the government is expected to run short of cash.
The problem with this scary talk is that there is little chance of default. The federal government has many ways to meet all payments for the foreseeable future.
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Even if the U.S. Treasury cannot sell any more debt to the public, it can easily get cash to meet the government’s funding needs. The Treasury doesn’t even have to resort to a fire sale of gold and land, although there are good reasons for selling many of these assets anyway.
Two direct changes in current practice will allow the government to pay its bills and, in the process, make government spending more transparent.
First, the Treasury can stop borrowing money and start printing it. While this will undoubtedly flood the economy with cash, the Federal Reserve can remove the excess liquidity by selling the more than $1 trillion in Treasury notes and bonds it currently holds.
Printing more money will be no more inflationary than what current monetary policy already has achieved. With short-term interest rates near zero and long-term Treasury rates around 3 percent, inflation expectations are low. The sale of bonds may push these rates slightly higher, but demand for Treasuries remains strong despite the so-called crisis.
Second, despite what you might be seeing and hearing in TV advertisements, the federal government has no reason to miss any Social Security or Medicare payments. Taxes deducted from our paychecks for these programs are deposited into funds that are responsible for paying the bills.
Over the past decades, the excess of what these funds took in over what they paid out was lent to the federal government for other uses. These funds still take in plenty to pay current benefits but also hold trillions in U.S. Treasury debt. These securities can be sold to the public to ensure no payments are missed. There is no truth to any claim that Social Security checks will be stopped.
For these reasons and others, the financial markets are not in a panic. The stock market is somewhat more volatile lately but nowhere near the turmoil that surrounded the Lehman failure.
Policymakers can’t seem to agree on what needs to be done — raise taxes or cut spending. No problem. Just print the money you need until the next election and let the voters decide.
Financial armageddon is not in sight.