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A Looming Debt Limit Crisis

Author: Roya Wolverson
January 4, 2011

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The year has begun with fresh signs of political infighting over raising the amount of debt the country can legally hold, threatening to delay progress on debt reduction and rattle international confidence in the U.S. economy. The government is expected to hit the legal limit on borrowing--$14.3 trillion--early this year, prompting Congress to choose between raising the ceiling (Bloomberg) or potentially defaulting on its obligations. Some congressional Republicans' calls to oppose the debt ceiling hike have raised fears of a looming political showdown over the issue. Senator Lindsey Graham (R-SC), often considered a political bridge-builder, said on Sunday he would link his vote on the debt ceiling (NationalJournal) to demands to reduce long-term spending obligations, including Social Security. Chairman of the U.S. Council of Economic Advisers Austan Goolsbee, meanwhile, warned against any political move that would play "chicken with the debt ceiling" (Politico) and damage "the full faith and credit of the United States."

The partisan conflict echoes a fallout between congressional Republicans and the Clinton administration over raising the debt ceiling in 1995, which prompted two government shutdowns and rattled financial markets. The consequences of repeating such a scenario would be far costlier now, warns David Min of the Center for American Progress, since "unlike in 1995, when our economic outlook was good, we are currently fighting our way out of the Great Recession and coming off of the worst financial crisis since the 1930s." A large and sudden drop in spending resulting from a debt ceiling freeze would prompt "a severe drop in economic growth and employment at a time when we can least afford it," says Min. Sustained partisan gridlock or government default could also raise U.S. borrowing costs, if bond market vigilantes divert (FT) their attention from peripheral European countries to the U.S. Treasury market and drive up interest rates.

Mounting concerns over government debt come at a critical time for the Obama administration, which is struggling to convince voters its economic recovery policies--including a $787 billion stimulus bill and an $858 billion tax cut plan--are helping the U.S. economic position even as they increase the nation's debt. House Republican plans to vote to repeal the Obama administration's new healthcare law (TheHill) or withhold its funding are weighing on Democratic budget plans elsewhere. In the American Spectator, the Republican National Committee's Ken Blackwell argues for legislators to use the pending debt limit vote to push for a balanced budget amendment that would "fundamentally address our nation's addiction to spending indefinitely." That would require lawmakers to resolve debate over whether fiscal tightening should involve increasing taxes (WSJ) or reducing government spending.

Whether debate will lead to serious action remains to be seen. The Brookings Institution's Alice Rivlin, part of the Obama administration's bipartisan deficit commission, says the burden lies with President Obama, who must be specific but open in his upcoming State of the Union budget proposals and the 2012 budget, as well as a cooperative incoming House Speaker John Boehner. Ultimately, says Rivlin, avoiding a debt crisis will require that "the president and the leadership of both parties are sufficiently scared of the consequences of gridlock on the budget that they work together to produce a sustainable multi-year budget plan."

More Analysis:

The Economist looks at the effect of bipartisanship on the U.S. economy in the long term.

This Congressional Research Service report looks at the history of the country's debt limit (PDF) and recent increases.

The Financial Times examines the pace at which the sovereign debt crisis will spread, its impact on U.S. growth, and potential damage to the nature of international finance.

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