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Debt-Ceiling Alarm Bell Tolls

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With the $16.4 trillion debt ceiling getting restored on May 19, alarm bells have started tolling across the country to address this highly politicized and polarizing issue to give it a fresh lease of life.

However, calming the frayed nerves, the U.S. Treasury has confirmed recently that higher-than-expected tax receipts and a hefty one-time payment by Fannie Mae to the tune of about $59.4 billion has deferred hitting the debt ceiling until at least the Labor Day.

But will delaying the inevitable be really helpful for the U.S. unless some corrective measures are implemented? Let us dig a little deep to find answers to these questions.

The History

The U.S. Treasury has defined the debt limit as "the total amount of money that the U.S. government is authorized to borrow to meet its existing legal obligations, including Social Security and Medicare benefits, military salaries, interest on the national debt, tax refunds, and other payments."

The financial prudence behind having a debt ceiling lies in the fact that it allows a form of accountability and enables the government to borrow further to meet its revenue shortfall, thereby giving it an opportunity to identify and target the underlying causes for the overspending. Or is it?

If having the diction of debt ceiling would have helped, the U.S. would not have required modifying it again and again. History reveals that since 1960 Congress has acted 78 separate times to permanently raise, temporarily extend, or revise the debt limit – 49 times under Republican presidents and 29 times under Democrats. So the obvious question then arises: Is the debt ceiling at all required?

The Fallout

The government seemed to have learned from its past mistakes, and the U.S. had a balanced federal budget with expenses tallying exactly with income in 2001.

But, as they say, ‘History repeats itself’ -- the U.S. economy again fell back in to the trap primarily due to three factors: the Bush-era tax cuts that added roughly $2 trillion to the national debt over the last decade; the Gulf wars in Iraq and Afghanistan, which added an additional $1.1 trillion; and the Great Recession, which led to the collapse of several financial giants like Lehman Brothers and Merrill Lynch, which was later acquired by Bank of America Corp. (BAC). Several other banks like JPMorgan Chase & Co. (JPM), Goldman Sachs (GS) and Morgan Stanley (MS) also felt the after-effects of the prolonged Great Recession.

The situation snowballed in to a crisis in 2011 when a periodic increase in debt ceiling was stalled by the Republicans, demanding a significant cut in federal spending. The crisis was eventually averted by the intervention of the President, but not until the U.S. had its casualty of a credit rating downgrade by Standard & Poors.

The stage is again set for a showdown this fall, but the question remains: Is the U.S. prepared to riseup at last or sink further down?

The Lifeline    

Although time is the best judge for this trillion-dollar question, the U.S. economy got a lifeline when data from the Treasury revealed that receipts for the six-month period ending Mar 2013 aggregated $1.2 trillion, up 12.4% year over year, versus a government spending of $1.8 trillion. This is equivalent to a year-to-date budget deficit of about $600 billion, the lowest since 2008.

The better-than-expected revenues were attributable to higher income tax payments, up 14.7% year over year, and improved corporate profit taxes, up 18.6% year over year, in addition to a significant contribution from Fannie Mae.

A relatively smaller yet noteworthy factor that pushed the revenue receipts was the underlying growth in the economy. Primarily, a dip in unemployment figures and ever-increasing stock price indices are the positive signs.

This averted possible ‘extraordinary measures’ by the Treasury as of now, allowing the federal government to finance its operations for about two months even after reaching the debt ceiling. These include 1) suspension of the sale of State and Local Government Series Treasury securities; 2) redemption of existing and the suspension of new investments in pension funds like the Civil Service Retirement and Disability Fund and the Postal Service Retirees Health Benefit Fund; 3) suspension of reinvestment of the Government Securities Investment Fund and 4) suspension of reinvestment of the Exchange Stabilization Fund.

But will the Treasury be eventually forced to utilize these measures if an amicable solution of raising the debt limit is not reached between the Republicans and Democrats sometime in September.

As a separate cushion, the Republicans have deftly passed a bill that would allow the government to pay interest on debts as well as prop up Social Security payments, even if a status quo is maintained for the federal borrowing limit. Although the bill promises to prevent any missed obligations that could trigger a formal default and pre-empt any potential debilitating shock to the economy, it eventually raises the debt limit by pushing these payments outside its purview.

In other words, it would be detrimental to the economy, earning it the vicious tag of a "default" by another name, probably due to which the White House has promised to veto it.

The Epilogue

No matter what the warring political parties do, the thorny issue of a potential crisis due to a debt-ceiling hit still persists. The short-term initiatives are likely to offer a temporary respite, but the ramifications could lead a death-blow to the economy unless a balanced fiscal policy is eked out.

As the U.S. stocks continue their unrelenting rally of reaching new all-time highs in most major indices, the market might be vulnerable to a correction any time soon. Only time will tell whether debt-ceiling alarm bells are indeed trigger for such an incident.

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