Budget Must Be Made Right Before Crisis Becomes Unavoidable

Public attention is focused on the debt ceiling debate. But the risk to the economy is not that the United States will default on its payments to domestic and foreign bondholders, but that America’s debt will lose its AAA rating.

The Senate has not yet passed a bill that would cut spending. On Wednesday, Senate Majority Leader Harry Reid, D-Nev., told House Speaker John Boehner, R-Ohio, that he would oppose Boehner’s Budget Control Act if it reached the Senate.

It’s unlikely that Treasury Secretary Timothy Geithner will allow America to miss debt payments. Under current practice, if the debt ceiling is not raised, Geithner has the authority to prioritize payments, as happens during a government shutdown.

To conserve funds, Geithner could delay payments to government providers and states. He could explore innovative solutions, such as selling assets to the Federal Reserve. The Fed would pay the Treasury, which could then use the funds to pay the nation’s bills.

For instance, the Fed could buy Treasury holdings of gold and silver bullion, or mortgage-backed securities (of which the Fed already holds about $1 trillion) in return for cash.

With congressional approval, the Fed might be able to buy other assets from Treasury, such as Federal lands, buildings, art and artifacts.

Transferring assets to the Fed would be a safe route because it would be “in the family” and could be done quickly. Even though it would increase the risk of inflation, because it would amount to an increase in the money supply, it’s worth considering in the short run.

But if our fiscal picture does not improve, and soon, America will lose its AAA bond rating. This means higher interest payments on what we borrow, and a budget that is further out of balance and harder to reduce.

Already the government borrows an outrageous 40 cents of every dollar spent. Moody’s and Standard and Poor’s indicated that we should reduce our deficit by about $4 trillion over the next decade.

Interest rates on government debt now average 2.5 percent, compared with 5.7 percent over the past 20 years. If interest rates rose to the prior average, America would be paying $700 billion more annually by 2020.

Spending an extra $700 billion annually is like putting in a Troubled Asset Relief Program into every year’s budget. Except it would be worse, because TARP funds were repaid, and interest payments are not. In Tuesday’s testimony before the Senate Finance Committee, Lawrence Lindsey, president and CEO of The Lindsey Group and former director of President Bush’s National Economic Council, said:

“The recent lessons from Europe or the many lessons of history from previous sovereign debt crises indicate that government bond markets function smoothly for long periods of time and then suddenly crash.” Lindsey testified that interest rates might move even higher than previous average rates, and sooner and more quickly than anyone is currently predicting.

He recommended trimming long-term entitlement costs, such as gradually adjusting Social Security and Medicare benefit formulas. Plus, cutting worthless projects.

A downgraded bond rating would not only raise the cost of future money borrowed by Uncle Sam, but would also weaken whatever leadership position America now has in the world.

Since all private borrowing costs are scaled up from Treasuries, as lenders are quick to tell us, so new loans for cars, houses, and credit cards would soon cost more.

Members of Congress, it’s the potential debt downgrade that’s the problem, not the debt ceiling. Get the budget in shape now.

This piece originally appeared in San Francisco Examiner

This piece originally appeared in San Francisco Examiner