It was indeed like an Alfred Hitchcock thriller. In every passing second, the audience, this time the global financial community, world leaders and a section of US citizenry, was gripped by suspense, excitement and uncertainty. Uncertainty first led them to fear and then to horror. The actors who played the leading roles appeared briefly on the set, read out the dialogue prepared for them and disappeared abruptly leaving the audience in a state of panic. As the clock started ticking down to the final day of reckoning, the mighty US Dollar started falling against other currencies which were also sickly, but less sickly than the dollar. On the other side of the coin, the prices of crude oil and gold started to rise to compensate for the fall in the value of paper currencies. The angry and panic – driven US public, fearing that they would lose everything they had been lavishly enjoying so far, started to jam the telephone lines and blog sites with protest messages addressed to Republican lawmakers who they have been told were the villains in plot.
What everyone did not know or conveniently chose to forget was that this movie had been screened many times before. On all those occasions, the movie was abruptly taken off the projector before the audience could reach an explosive climax.
The current battle between the Democratic President Barack Obama and Republican – held US House of Representatives over the raising of the US national Debt Limit is yet another screening of the same movie. It is widely believed that the thriller would be taken off the projector as it had been done on previous occasions just before the dawn of August 2, 2011 thereby denying the audience of the expected thrilling climax but delivering a sense of relief.
The US Debt Ceiling Crisis
The debt ceiling crisis has occurred due to an obvious reason: the US Federal Government does not have enough cash to pay its obligations unless it borrows money by issuing new US Treasury bills and bonds.
Why cannot it borrow more to pay its bills? This is because it has already reached the ceiling on borrowings fixed by the US Congress at US $ 14.3 trillion. This ceiling was reached by May, 2011 and unless the ceiling is increased, the Treasury does not earn enough revenue to pay its bills. When the problem started to knock at its door the Obama administration requested the Congress to raise the ceiling by $ 2.4 trillion but it was refused by the Republican held Congress by the support of some Democratic Congressmen from Obama’s own party by majority vote, 318 opposing and 97 voting for.
In the interim period, like any person who has been faced with a cash problem, the US Treasury has paid its bills by scraping up all the available cash in the funds under its control and using the pension contributions by the US Federal Government employees. This cash too is to exhaust by August 2, 2011 and if the Congress does not raise the ceiling on borrowings by that date, as Obama himself has publicly warned, the US Government will have to default its obligations for the first time in its history. Obama made history by becoming the first coloured President of the US in 2008. Three years later, it appears that he is going to make history again by overseeing the default of obligations by his government.
The bills involved are all public and investor sensitive payments such as social security payments, medical payments, salaries and interest on US debt. Hence, any default of these bills will cause wide – spread public and investor uproar leading perhaps to street riots.
The parties to the dispute are well aware of these perilous consequences. Yet, they have locked horns blaming each other and making attacks and counter – attacks while the world at large which has a stake in the affair is watching impatiently till an acceptable resolution is made.
The Dispute
The dispute has been over whether a ‘clean increase’ in the debt ceiling should be given or whether conditions should be attached to it. Obama wants a clean increase to wade through the current crisis. Republicans want to attach the condition that the debt ceiling increase should be accompanied by a deficit reduction programme based on spending cuts and not on increases in taxes.
Both parties agree that the US cannot continue with its current overspending as reflected by soaring budget deficits and rising national debt. In 2000, President Bill Clinton managed to convert US’s deficit budgets to a surplus of $ 400 billion. But, that was a temporary gain because under President George W Bush, the US went back to budget deficits due to the global wars it was engaged in and the rising economic problems it was facing back at home. Hence, by the time Obama took over in 2008, the US budget deficit had soared to an unmanageable $ 1.2 trillion or about 10% of the country’s GDP. By now, the deficit has increased to $ 1.5 trillion.
Obama in his State of the Union address 2011 promised to cut the budget deficit by about $ 500 billion by freezing the spending at the current levels over the next five year period. He also promised the US citizenry and the global community that the US will be a good boy by trying to live within its means, the way a normal family would plan its incomes and spending.
So, the bone of contention is whether the US should go for a short term solution now and plan for the future later or whether it should do both simultaneously. Up to the end of July, there was no agreement on this, but many believe that it is possible to reach a compromise solution before the country faces the actual threat of self - destruction.
Raising the Debt Ceiling has a long history
It was in 1917 that the US decided to fix a debt ceiling to facilitate borrowing funds in large amounts so that the Congress does not have to approve it annually as it had done before. Since this time, the US has increased its debt ceiling from time to time. From 1962, the ceiling has been increased by 74 times; from 1980, by 36 times. During Obama’s period, it has been raised 3 times from $ 10.6 trillion in 2008 to $ 14.3 trillion in February 2010.
Every time the debt ceiling was raised, the desire to restore budgetary balance and reduce the public debt was expressed by the legislators and the promise was delivered by the incumbent presidents. In 2006 when President Bush wanted the Congress to raise the ceiling, it was Obama himself who made the strongest protest: he said that the need to raise the ceiling was a sign of leadership failure. He further added that it was a sign that ‘the US government cannot pay its own bills’. But that was when he was in the opposition and when in the government, he had to play the same game as his predecessors.
Hence, the US budget deficits and rising public debts have been a concern.
Summarising these concerns, the US Congress Budget Office in its 2011 Report on Long term Budget Outlook has warned that without major policy changes, the large budget deficits and growing
public debt will continue with the adverse consequences of reducing the national savings, raising foreign borrowings, increasing interest rates and moderating domestic investments.
So, the US authorities are well aware of the ailment with which the US economy is chronically and now acutely afflicted. What they appear not to know is the solution.
The US Government: the Bad Boy that delivered the ‘American Curse’
There are two reasons why the US has become a bad boy, especially after the World War II. One reason is the Keynesian Ghost that has influenced and still continuing to influence the US policy makers. The second reason is the elevation of the US to the world’s central banker nation, a blessing at that time but now turned out to be the ‘American curse’, and the desire for enjoying the perks associated with that role.
Keynes has been far more influential on the US economic policy than any other economic philosopher of the day. His policy prescription that the governments in advanced countries can beat economic recessions successfully by increasing the government expenditure was considered a plausible solution to the problem of economies fluctuating from economic booms to economic slumps, a phenomenon known as business cycles. Daniel Yergin and Joseph Stanislaw have described in their ‘The Commanding Heights’ how Keynesianism got rooted in the policy base of the US administration. According to them, it was the Economics Department of Harvard University, more specifically its leading academic Alvin Hansen that was first converted to Keynesianism. From Harvard, it soon spread to Washington like a wild fire because it enabled the government to intervene in the economy for the public good without adopting more intrusive methods that had been practised in countries like the Soviet Union. So, Keynesianism provided the philosophical foundation to stop the spread of communism.
Since the World War II, the US administration adopted the Keynes’ policies to attain full employment in the US economy by raising government expenditure. The result was the emergence of deficit budgets and ensuing increases in the public debt to unmanageable levels threatening the very leadership of the US in the global economy unless a quick policy reversal is made.
Profits from being the World’s Central Banker Nation
In terms of the Bretton Wood Agreement under which the IMF and the World Bank were created, the US became the world’s official central banker nation. Even after the US relinquished these responsibilities unilaterally in 1971, it became the world’s unofficial central banker nation.
One privilege which any central banker enjoys is the enormous profits it can make as long as the cost of producing its currency is less than the face value of the currency it produces. In economic parlance, this profit is known as ‘seigniorage’ and central bankers are termed ‘seigniorage seekers’.
Suppose the cost of issuing a US dollar is just 5 cents. When the US government issues one dollar, it acquires from the public goods and services worth of one dollar on credit because a dollar bill is a debt note issued by the US government. Its obligation to the holder is to allow him to buy a dollar’s worth of goods and services from the US economy or from any other place where a seller is willing to accept it in exchange of a dollar’s worth of goods and services. This may or may not happen depending on the desire of the holder of the dollar bill.
Hence, for every dollar bill issued, the US government makes a profit of 95 cents, according to the above example. The US has been lavishly enjoying this seigniorage without thinking that it could become a curse one day.
Central bankers are normally restricted in their use of the seigniorage for lavish expenditure programmes by the governments. For instance, in the Monetary Law Act under which the Central Bank of Sri Lanka has been set up, seigniorage has been deliberately hidden by the Act’s architect, John Exter, within the Bank’s accounting system. Accordingly, any profit earned by the Bank, while it is still a liability of the Bank, is simultaneously reduced from its demand liabilities thereby keeping the total liabilities of the Bank unchanged. The use of profits for government expenditure programmes is a separate process under which the Bank has to appropriate its profits deliberately to the government.
This wisdom of responsible use of the seigniorage has not been practised by the US government. It can continue to use the seigniorage because the other nations use those dollar bills as reserves or a medium of payment without repatriating them to the US.
The Tense Global Community
But the global community which has relied on the Dollar as a reserve currency and a medium of payment has become tense, nervous and panicky. If the dollar falls, it would wipe out a substantial portion of their wealth. To protect themselves in a small way, they are transferring dollar assets to other currency assets and converting dollars to gold. But the global community cannot get rid of dollars completely, because in their wild race to buy other currencies and gold, their prices would rise to exorbitant levels. That currency and gold bubble, when eventually pricked, would be the end of the world’s monetary system.
Hence, countries like China, Japan, India and Taiwan which hold huge dollar assets have become more nervous than Obama in this present US debt ceiling crisis.
Prescriptions: Some are Hilarious
Now that Obama and the US Congress are in a deadly deadlock, some have offered wise counsel as to how he could overcome the impasse.
The Yale Law School Professor Jack Balkin has offered three suggestions, all being circumventions of law rather than finding a lasting solution to the problem created by the irresponsible deficit financing and rising public debts.
First, he says that Obama can take cover under section 4 of the 14th Amendment to the US Constitution. According to this section, the US public debt, including that is raised to pay pensions and soldiers suppressing rebellions and insurrections shall not be questioned. Hence, the Congress has no power to block Obama and he can continue to raise public debt irrespective of the debt ceiling fixed by the Congress.
The second suggestion is the more hilarious one. According to US laws, the US Treasury can issue platinum coins of any denomination without the approval of the congress. He, therefore, suggests that the Treasury issue two platinum coins in the denomination of $ 1 trillion each and deposit the same with the US Federal Reserve Bank, the country’s central bank, to its credit. Then, the Treasury can draw cheques against its deposit balance and make payments.
The third suggestion is that the Federal Reserve Bank can buy assets worth of $ 2 trillion from the Federal Government and allow the Treasury to draw cheques to that amount.
These three suggestions will help Obama to circumvent the law and survive for one more day. But it will not give confidence to the international community since the first one calls upon Obama to function like a dictator ignoring the laws and the wishes of his law makers and the last two call upon the Federal Reserve Bank to increase its money supply against either worthless or unusable assets thereby sowing the seeds of the future inflation and causing the eventual downfall of the dollar.
Keynes’ Ghost being resurrected by mainstream economists
Leading economists such as Paul Krugman, Larry Summers and Brad De Long have made somewhat a rebellious suggestion. They have opined that the debt ceiling should be raised and the government, instead of cutting, should actually increase its spending. This is in order to stimulate the economy and thereby raise output and employment so that in the long run, the US government has no either a budgetary problem or a national debt problem. A similar view was expressed by the Federal Reserve Bank’s Chairman Ben Bernanke when he addressed a congressional meeting. He said that if the Congress does not raise the debt ceiling, he has no choice but to stimulate the US economy with a new stimulus package.
It is inconceivable that, as Albert Einstein once remarked, how a cause of a problem can become its solution as well.
Despite the massive size, these stimulus packages have not delivered the desired results as demonstrated by rising unemployment, low economic growth and shattering consumer confidence in
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the US. Instead, they have delivered bigger trade deficits, bigger budget deficits and need for raising additional national debt.
This is the popular Keynesian Ghost being resurrected without Keynes’ consent. Since it allows everyone to continue to dance on the table, it would be sweet music to both politicians and angry US citizenry.
Keynes’ Ghost has wreaked havoc to the US economy threatening its status as the global economic leader. It was William McChesney Martin Jr, Federal Reserve Chairman during the 1950s that said that Federal Reserve’s job is to take the punch bowl away just as the party gets going. The suggestions by the leading economists and Bernanke point to the opposite. That is, the Federal Reserve should continue to refill the punch bowl and allow the dancers at the party to dance on the table, perhaps until they all get exhausted and collapse.
The global community, especially China which has the biggest stake, is watching sadly whether this is happening.
(W.A. Wijewardena can be reached at waw1949@gmail.com )
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