Will the US Government default on its debts?

by Barry M-C on May 18, 2011

According to The Telegraph, President Obama declared late on Sunday (15th May) that:

“If investors around the world thought that the full faith and credit of the United States was not being backed up, if they thought that we might renege on our IOUs, it could unravel the entire financial system.”

Whilst this is extremely unlikely, the growth in the US government’s indebtedness is beginning to sound alarm bells in the world’s capital markets.

Last month, it was reported that Standard and Poor’s Ratings Services had lowered its long-term credit outlook for the U.S. government from “stable” to “negative” precisely because of that growing indebtedness and the persistence of substantial budget deficits. This would be the first step to S&P reducing the U.S. government’s much-prized AAA credit rating – and any reduction in rating would make it more expensive to finance its debts.

US raids civil service pension fund as it hits $14.3 trillion debt limit - The Telegraph, 16/05/11

On April 18 2011, Voice of America news reported a media teleconference with David Beers, S&P’s global head of sovereign ratings, wherein Beers said:

“A negative outlook means that in S&P’s opinion, there is at least a one in three chance that over roughly the next two years, that we could lower the rating…. It also means, conversely, that there is, in the committee’s opinion, a two-thirds chance that the rating might not change.”

The U.S. government’s debt ceiling is limited by law at $14.3 trillion – and that limit has now been reached. Yet, rather than aggressively tackle the budget deficits and pay-off the national debt, we see the President looking to U.S. Congressional leaders to increase the debt ceiling and for higher taxes.

In April, according to the Voice of America report, President Obama’s Press Secretary, Jim Carney, suggested that fiscal reform – i.e. taxes – was the main way to bring the debt under control. Carney told reporters that S&P’s revised outlook serves as:

“A reminder that it is important that we reach agreement on fiscal reform is always valuable, and that’s essentially what it is…. It is another indication of the importance of both sides coming together and grappling with this problem and getting to a resolution.”

Matters got worse on Monday 16th May, when Treasury Secretary Timothy Geithner wrote to Congressional leaders explaining that payments into the US government’s civil service pension fund had been suspended so as to free up almost $150 billion (approximately £92 billion) as the debt ceiling neared – as reported by The Telegraph. (In an appeal to part of its core electoral constituency, the Democratic administration also noted that once a new debt ceiling has been agreed, any shortfall on this government pension pot would be made good; and no retired workers would lose out.)

Higher taxes are not the answer to runaway government spending; if anything, they shield politicians from the folly of pursuing unsustainable spending increases. Higher taxes will inevitably slow economic growth and ultimately reduce the overall level of tax receipts the government collects. What’s really necessary to reduce and eliminate budget deficits and to pay off the national debt is a reduction in overall government spending.

A US default is a long way off but with no agreed bi-partisan plan to contain and reduce the debt, nor any plan to tackle the structural budget deficit by reducing spending, the growth of the U.S. government’s debt is clearly making markets nervous and making the debt more costly to fund.

And then there are the tens of trillions of unfunded social security liabilities and other welfare entitlements…. In his article, The Coming Entitlement Tsunami, Cato Institute’s Michael Tanner estimates that there are something like $15.8 trillion of unfunded liabilities in social security.  That’s $1.5 trillion more than the present debt ceiling of $14.3 trillion that is causing so much heartache in Washington DC !  But this $15.8 trillion in unfunded social securities is itself dwarfed by the estimated $50 – $100 trillion shortfall in unfunded Medicare liabilities that are largely ignored by U.S. legislators.

If President Obama really wants to avoid his own warning that if “investors around the world thought… we might renege on our IOUs”, which would lead to an “unravel[ling] [of] the entire financial system”, then it becomes absolutely imperative that he starts cutting his own budget deficit in earnest, and makes a start reducing the U.S. national debt as a prelude to tackling the unfunded liabilities of the welfare state.

Unfortunately, I don’t believe that President Obama will become a Tea Party convert anytime soon…

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