Subject: The Conservative Pledge to Freeze the Debt Ceiling Is a Looming Disaster - (40 percent cuts in every aspect of government except payment of interest on national debt
From: "Michael Andrews" <[email-masked]>
To: "Hunter Biden" <[email-masked]>, "Eric Schwerin" <[email-masked]>
Date: Thu, 28 Oct 2010 14:12:08 -0400

If the Republicans follow this path the President would have not  
choice but to initiate a rapid withdrawal from Iraq and Afghanistan as  
well as deep cuts every other program.  My mischevious side would find  
the political implications of what Republicans want to do as very  
interesting in the Chinese provrebial sense.

The Big Freeze
The Conservative Pledge to Freeze the Debt Ceiling Is a Looming Disaster

Led by the advice of Newt Gingrich, the former House Speaker who was  
the architect of the 1995-96 debt ceiling crisis, many conservatives  
are clamoring for a repeat of this past episode in recklessness.

SOURCE: AP/Richard Drew
By David Min | October 28, 2010

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By law, a statutory limit restricts the total amount of debt the  
federal government can accumulate. Only Congress can raise this limit.  
On the heels of the worst recession since the Great Depression, this  
“debt ceiling” is projected to be reached sometime in February 2011.  
Increasingly, conservatives are pledging to vote against any increases  
to the debt ceiling—even if this means shutting down the federal  
government. This reckless pledge would have disastrous consequences  
for the U.S. economy and the global financial markets, and would  
severely worsen the long-term budget situation to boot.

This conservative pledge has historical antecedents. In the fall of  
1995, congressional Republicans refused to raise the debt ceiling for  
a period of about six months, until they reversed course in March 1996  
in response to plummeting poll numbers. This original “debt ceiling  
crisis,” as it’s become known, was extraordinarily costly, roiling the  
financial markets and forcing two government shutdowns.

The consequences of refusing to raise the debt ceiling would be even  
more costly today, given the precarious state of the U.S. economy and  
global financial markets, and potentially could be disastrous. Unlike  
in 1995, when our economic outlook was good, we are currently fighting  
our way out of the Great Recession and coming off of the worst  
financial crisis since the 1930s.

Nonetheless, led by the advice of Newt Gingrich, the former House  
Speaker who was the architect of the 1995-96 debt ceiling crisis, many  
conservatives are clamoring for a repeat of this past episode in  
recklessness.

The budgetary consequences of this conservative pledge would be  
catastrophic and far-reaching, forcing the immediate cessation of more  
than 40 percent of all federal government activities (excluding only  
interest payments on the national debt), including Social Security,  
military operations in Iraq and Afghanistan, homeland security,  
Medicare, and unemployment insurance. This would not only threaten the  
safety and economic security of all Americans, but also have dire  
impacts for the economy and job growth.

In short, the economic consequences of such a large and precipitous  
drop in spending would be crushing, and almost certainly result in a  
severe drop in economic growth and employment at a time when we can  
least afford it.

Moreover, such a move could lead to a panic in the international  
financial markets. Following the 2008 financial crisis, we have seen  
debt crises hit Ireland, Greece, and Italy, with fears that this could  
spread further and cause a global economic downturn. The financial  
markets are on edge today, with U.S. Treasury bonds being the safe  
haven for most investment capital. Refusing to raise the debt ceiling  
would recklessly disrupt the sale and purchase of new Treasury bonds,  
and could potentially cause a run on outstanding Treasurys as well, as  
investors sought other investments. This could have catastrophic  
consequences for our economy as well as the economic stability of the  
rest of the world.

Refusing to raise the debt ceiling would also exacerbate the problems  
with our long-term budget outlook. The budget deficit right now is the  
result of two distinct sets of changes since 2001, when we last had a  
budget surplus. First, a series of long-term policies enacted by the  
Bush administration—most notably the Bush tax cuts of 2001 and 2003,  
the decision to fight two major wars without raising taxes, and the  
passage of an unfunded Medicare Part D prescription drug program— 
created permanent structural budget deficits that will remain with us  
over the long term unless they are addressed. Second, the poor economy  
caused a drop in tax receipts alongside higher “countercyclical”  
spending, such as for unemployment insurance and food stamps.

Implementing a debt ceiling freeze ignores the first set of issues and  
makes the second set of issues worse by forcing a massive  
multitrillion dollar hit to an already struggling economy and  
threatening to take us into a second Great Depression. This is hardly  
responsible policymaking. So let’s delve a little deeper into the  
consequences of such conservative folly. As we will demonstrate, the  
results of a replay of 1995 in 2011 would be the height of  
recklessness for our economy and global financial markets.

A replay of 1995
The most recent pledge to freeze the federal debt ceiling is notable  
because congressional Republicans tried the same thing following their  
takeover of Congress in 1995. That fall, Republicans refused to raise  
the debt ceiling unless then-President Bill Clinton agreed to enact  
major planks of the radical “Contract with America” proposed by the  
Republican Party, such as a $270 billion cut to Medicare, steep cuts  
to education funding, and massive deregulation measures. Indeed, then- 
Speaker of the House Newt Gingrich at one pointthreatened to force a  
default on the national debt if Republicans did not get their way.

This standoff, which lasted until March 1996, ended with the  
Republicans backing down as the public increasingly became turned off  
by the government shutdowns that resulted.

The “1995-96 debt ceiling crisis,” as it is known, caused significant  
turmoil for our economy, forcing the Department of Treasury to suspend  
all new debt issuances and causing two temporary shutdowns of all  
“nonessential” federal government activities, including a cessation of  
toxic waste cleanups, disease control activities, and a suspension of  
many law enforcement and drug control operations, among many others.  
Ultimately, this episode cost the American taxpayer over $800 million,  
and rattled the confidence of international investors in U.S.  
government bonds.

Indeed, it was only through the use of some fairly extraordinary  
measures by President Clinton’s Treasury Department, including a  
temporary use of retirement funds for former government employees,  
that the United States managed to avoid defaulting on its national  
debt during this period. Unfortunately, such measures would not be as  
effective today, asanalysts at Deutsche Bank found. They worry that if  
it happened today the federal government would “not be able to stave  
off a government shutdown (or possible suspension of bond payments)  
for long.”

The precarious budget situation
Conservatives’ call for a debt ceiling freeze looks even more  
senseless when one considers that our economy is struggling to recover  
from a severe recession. Because economic growth remains anemic, tax  
receipts are flat after falling sharply, which makes it particularly  
difficult to balance the budget. Refusing to raise the debt ceiling  
would essentially force the federal government to balance the budget  
immediately, at a time of cyclically low revenues. While this may  
sound appealing to deficit hawks and deficit peacocks alike, it would  
actually have catastrophic consequences, both in the short term and  
the long term.

A $1.3 trillion deficit is projected for FY 2011, on a total budget of  
$3.8 trillion. If we assume that the Obama administration did not want  
to default on the national debt, and thus continued to make interest  
payments on outstanding U.S. Treasury obligations ($244 billion), then  
being forced to balance the budget next year would mean cutting over  
40 percent of all other expenditures.

But some federal spending is more important than others, right? Let’s  
assume that we keep certain “sacrosanct” programs whole, not cutting  
Social Security ($728 billion), defense spending during a time of war  
($701 billion), Medicare ($507 billion), Medicaid ($262 billion), and  
benefits for military veterans ($126.5 billion). If we did that and  
then eliminated spending on all other government programs, we would  
still be looking at a small deficit. Yet such a move would mean no  
FBI, no Department of Justice, no Homeland Security, no border  
security, no education funding, no unemployment insurance, no school  
lunches, no national parks, no food stamps, no student loan funding,  
no air transportation safety, no drug enforcement, no food and drug  
safety, etc. etc. etc., ad nauseum.

Such severe expenditure cuts would be devastating in two ways. First,  
they would eviscerate the basic services and protections offered by  
our federal government, leaving our country in perilous danger from a  
myriad of threats and many of its most vulnerable citizens without a  
safety net. Americans would be vulnerable to increased crime, drugs,  
terrorism, food safety, and air traffic safety, to name just a few.  
And these spending cuts would slash the social obligations we have  
promised to military veterans, the elderly, and students, among  
others. Such large spending cuts couldn’t simply be confined to  
nonessential services. They would cut to the very core of the  
protections and core benefits provided by the federal government.

Second, these large spending cuts would increase unemployment and  
severely dampen economic growth, destroying any prospects of a  
sustained economic recovery. The resulting job loses and the steep  
cuts to unemployment insurance, food stamps, and other federal safety  
net expenditures would create a reverse “multiplier effect” that would  
cause a large dip in economic growth.

The precarious state of the global financial markets
The conservative pledge to freeze the debt ceiling would also lead to  
some fairly momentous problems in the world’s financial markets.  
Following the financial crisis of 2008-2009, which exposed problems  
with many private financial instruments that were previously thought  
to be safe, such as money market funds and AAA-rated asset-backed  
securities, investors sought safe haven by investing in sovereign  
debt. Unfortunately, sovereign debt crises in Greece and Ireland have  
caused significant uncertainty in European financial markets, and as a  
result, investors have flocked to the perceived safety of sovereign  
debt issued by the United States, which has never defaulted in its  
history.

A freeze on the debt ceiling could erode confidence in U.S. Treasury  
bonds in a number of ways, creating further and wider panic in  
financial markets. First, by causing a disruption in the issuance of  
Treasury debt, as happened in 1995-96, a freeze would cause investors  
to seek alternative financial investments, even perhaps causing a run  
on Treasurys. Such a run would cause the cost of U.S. debt to soar,  
putting even more stress on our budget, and the resulting enormous  
capital flows would likely be highly destabilizing to global financial  
markets, potentially creating more asset bubbles and busts throughout  
the world.

Second, the massive withdrawal of public spending that would occur  
would cause significant concern among institutional investors  
worldwide that the U.S. would swiftly enter a second, very deep,  
recession, raising concerns about the ability of the United States to  
repay its debt. Finally, the sheer recklessness of a debt freeze  
during these tenuous times would signal to already nervous investors  
that there was a significant amount of political risk, which could  
cause them to shy away from investing in the United States generally.

Taken together, these factors would almost certainly result in a  
significant increase in the interest rates we currently pay on our  
national debt, currently just above 2.5 percent for a 10-year Treasury  
note. If in the near term these rates moved even to 5.9 percent, the  
long-term rate predicted by the Congressional Budget Office, then our  
interest payments would increase by more than double, to nearly $600  
billion a year. These rates could climb even higher, if investors  
began to price in a “default risk” into Treasurys—something that  
reckless actions by Congress could potentially spark—thus greatly  
exacerbating our budget problems.

The U.S. dollar, of course, is the world’s reserve currency in large  
part because of the depth and liquidity of the U.S. Treasury bond  
market. If this market is severely disrupted, and investors lost  
confidence in U.S. Treasurys, then it is unclear where nervous  
investors might go next. A sharp and swift move by investors out of  
U.S. Treasury bonds could be highly destabilizing, straining the  
already delicate global economy.

Imagine, for example, if investors moved from sovereign debt into  
commodities, most of which are priced and traded in dollars. This  
could have the catastrophic impact of weakening the world’s largest  
economies while also raising the prices of the basic inputs (such as  
metals or food) that are necessary for economic growth.

In short, a freeze on the debt ceiling would cause our interest  
payments to spike, making our budget situation even more problematic,  
while potentially triggering greater global instability—perhaps even a  
global economic depression.

The very idea of a federal debt freeze among the radical right in our  
country, while they continue to ignore responsible deficit reduction  
measures and continue to focus on the wrong policy solutions,  
exemplifies their obstinacy as much as their short-sightedness. A  
freeze on the debt ceiling, or shutting down the federal government  
will not reduce the federal budget deficit and will in fact increase  
it over the long run by tipping the global economy into depression.  
Voters may assume that conservative candidates will not live up to  
their pledge of recklessness once they understand the consequences.  
This is a risky gamble, particularly given the precedent already set  
by conservatives in 1995.

David Min is Associate Director for Financial Markets Policy at the  
Center for American Progress.