A way around the debt-limit impasse

Contrary to conventional wisdom, the United States does not have to default on its debt, and the Social Security and Medicare checks can continue to go out, even if Republicans and President Barack Obama cannot strike a deal to raise the debt ceiling by Aug. 2.

Though the government cannot borrow additional money, it still has tax revenues equal to about 55 percent of expenses — $2.2 trillion against expenses equal to about $3.8 trillion, for a $1.6 trillion deficit. With those tax revenues, Washington can fund interest on the national debt, Social Security, Medicaid and crucial national defense responsibilities. With the interest on the debt honored, the government can sell new bonds to replace bonds that come due without piercing the statutory debt limit.

Under this scenario, interest, benefits to seniors and defense would absorb virtually all tax revenues. It would appear the other functions of government would have to shut down — but the administration has other options.

The Treasury has the power print money to pay its bills. That would create the danger of too much money in the hands of the public and, thus, inflation, but the Federal Reserve has options to neutralize this problem. The Fed holds on its balance sheet about $2.6 trillion in securities, mostly Treasury bonds. As the Treasury prints money to pay its bills, the Fed could sell bonds to the public to keep the amount of money in circulation from rising.

How? Remember that the money supply is currency the public holds in its wallets and deposited in checkbooks — but the statutory debt limit applies to Treasury bonds held by the public and the Fed.

At $1.6 trillion a year, the process of the Treasury paying its bills by printing money and the Fed selling off bonds to absorb the excess cash in circulation could keep the government running past the next election.

Also, since 2007, government spending has jumped $1.1 trillion, but only $200 billion was needed to cover inflation — the $900 billion additional was new programs and benefits and higher pay. That has increased federal spending's share of gross domestic product from 19.6 percent to more than 25 percent.

Temporarily slicing that additional government spending by $450 billion, by executive order, would likely stand up in court as an emergency measure. It would be good politics for both sides — either the president is right and Americans would see how painful it is to cut government that much, or Republicans would be able to point that we are better off.

The Treasury would have to print about $1.2 trillion a year in new money, and the Fed would sell an equal amount of securities from its balance sheet; that maneuver would take us until a new Congress is seated and a reelected President Obama or his successor has a clear mandate.

Kicking the can again? Perhaps, but in 2012, both the president and his opponent would have to table specific alternatives for slashing the deficit and restoring normal operations, and the winner would emerge with a mandate for his plan.

Right now, neither side is offering credible plans. The president's taxes on the rich and other schemes would only slash at best $150 billion annually from the $1.6 trillion deficit, and the Republicans about a similar amount in spending cuts they have managed to propose.

Neither side is talking about harnessing the rapidly rising prices the government pays for health care — both sides just talk about trimming benefits a bit or the pain of it. The United States pays double, or more, than European governments for drugs, and suffers from large disadvantages in insurance administration, hospital efficiency and tort costs. Regulating those prices is a tar baby no one in Congress or the White House wants to put his arms around — but we are not getting out of this mess without doing so.

Ditto for retirement ages for Social Security and the vast array of federal pensions and state pensions the federal government indirectly helps finance.

The absence of frank discussion of financing options beyond Aug. 2 is the fault of two men. Though Treasury Secretary Timothy Geithner serves at the pleasure of the president, and Fed Chairman Ben Bernanke must answer frequently to Congress, both men have a responsibility to articulate the genuine budget and economic challenges before the nation, and both men can easily find other satisfying and better paying jobs in a pinch.

In similar crises, past cabinet members have stepped up — consider the conduct of senior Justice officials in the last days of the Nixon administration, or Alan Greenspan's willingness to talk frankly about federal policies.

Secretary Geithner needs to draft plans to keep the government going and be quietly frank with political leaders about those plans. And Chairman Bernanke would then concur with how the Fed can respond. Sadly, Messrs. Geithner and Bernanke are shirking the responsibilities.

Peter Morici is a professor at the University of Maryland's Smith School of Business and former Chief Economist at the U.S. International Trade Commission. His email is pmorici@rhsmith.umd.edu.

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