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The insanity of the debt-ceiling standoff

Minnesotans are currently enduring the ramifications of a state government ground to a halt by stubborn and shortsighted legislators. Politicians in the nation’s capital, meanwhile, appear poised to outdo those in St. Paul by engaging in an even higher-stakes game of brinksmanship, with the fate of global financial markets on the line. Unless Congress acts to raise the nation’s debt ceiling, the United States will face the proposition of defaulting on its debts for the first time in the country’s history. The fact that the country is in this situation at all is absurd, and unless lawmakers quickly come to an agreement, the ramifications of their actions will be devastating and long-lasting.

The debt ceiling set by Congress has been raised more than 70 times over the last five decades. In recent years, the increases have provided members of both parties opportunities to pontificate about the perils of raising the ceiling, and even to vote against doing so, safe in the knowledge that it was already clear the measure would pass.

Now, however, the country faces a grave situation. The debt ceiling must be raised immediately, regardless of the short- or long-term solution regarding the country’s finances. This is not a political statement but a mathematical one. Federal government spending on just Social Security, Medicare, Medicaid and defense is expected to exceed all federal government revenues in 2011. The immediate cuts required to other areas of government spending would dramatically depress economic growth and likely plunge the economy back into a recession.

Consequences would be catastrophic
A default by the United States on its debt would have catastrophic consequences for the global economy and financial markets around the world. United States Treasury obligations are universally regarded as being risk-free. A default on the global economy’s risk-free asset would send shockwaves throughout the financial system.

There are literally no securities more widely held and more intertwined with the global financial system than U.S. Treasury obligations. In truth, it is impossible to know the full ramifications that a United States default would create. Not only has such an event never occurred, it has never even been seriously imagined. It is not a stretch to conclude that the impact would eclipse that of the financial crisis of 2008, however. A default would push us into unchartered waters, with neither GPS, nor maps, nor stars by which to navigate.

Yet many prominent politicians steadfastly continue to act as hostage takers who are unwilling to negotiate. Minnesota’s own presidential hopefuls are chief among them. Former Gov. Tim Pawlenty recently urged Republicans in Washington to “draw lines in the sand” regarding the debt-ceiling issue. Rep. Michele Bachmann was more direct in her first campaign ad in Iowa, stating bluntly, slowly, and with emphasis, “I will not vote to increase the debt ceiling.”

Perhaps this unwillingness to compromise should not be surprising, given the utter lack of political discourse in Washington today. Still, in light of the staggering stakes, the lack of a willingness to live in reality is stupefying.

U.S. reputation at stake
The decision to use the debt ceiling as a weapon puts at risk the most valued asset of the United States – its reputation. United States Treasury obligations are considered to be risk-free because they are backed by the full faith and credit of the United States government. The unconscionable willingness of certain members of Congress to put that reputation in jeopardy threatens to wreak havoc on financial markets, significantly harm our economy, and forever raise the risk premium, and therefore the borrowing costs, associated with United States government debt. 

The most frustrating aspect of this entire affair is the fact that it is completely unnecessary. This is not Greece. The United States is not insolvent. The United States is not in a liquidity crunch. This is an artificial crisis, born of an arbitrary decision to set a ceiling and perpetuated by the stubbornness, or cluelessness, of select lawmakers who apparently fail to appreciate the severity of the situation. Not only is there more self-serving rhetoric than ever before, but also a complete void of sensible, goal-oriented dialogue among those entrusted to ensure our economic stability and longevity.      

Certainly a long-term solution to the country’s revenues, expenditures and deficits must be reached. Both sides will need to compromise if anything is ever to be accomplished. But this is neither the time nor the forum for such a debate. Hijacking the process of raising the debt ceiling at this critical time in order to score political points is stunningly irresponsible, even by the deplorably low standards of today’s political environment.

The world has more than enough financial challenges at present. Voluntarily adding another crisis that would dwarf the rest is ludicrous.  

Sean P. Smith is an investment analyst and member of the Investment Committee at Accredited Investors Inc., a comprehensive fee-only wealth management firm located in Edina. He can be reached at sean [at] accredited.com.

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