In the upcoming debate over the national-debt ceiling, the stakes couldn’t be higher. The economic recovery has stalled. The debt mounts by $4 billion each day.
With things so bad, the prospects for real spending cuts and reforms to limit the federal Leviathan are much improved. The shoes began dropping last month.
On April 18, the rating agency Standard & Poor’s lowered its outlook for America’s long-term credit rating from “stable” to “negative.” As CNNMoney reported: “The change means that there is a one-in-three chance that S&P could downgrade the nation’s ‘AAA’ credit rating within two years. That would make it harder for the U.S. government to borrow money to fund its activities.”
The next shoe dropped when Bill Gross, manager of PIMCO, the world’s largest bond fund with $1.2 trillion in assets, soured on the quality of U.S. government debt. PIMCO sold off all of its U.S. government holdings.
Throw in a steady ringing of fiscal alarm bells at the International Monetary Fund and the concerns of just about every sober-minded budget expert in the nation, and it’s clear we have one mighty fine mess on our hands.
Together these developments have realigned expectations with respect to the debt-ceiling legislation. Before April 18, the media narrative presumed that the sole threat to America’s credit rating was (to put it archly) conservative lawmakers’ rapacious desire to cut spending.
Liberal lawmakers such as Sen. Chuck Schumer (D., N.Y.) argued that the only thing we had to fear was, not fear itself, but these unhinged Republicans who would insist that any increase in the debt ceiling be accompanied by trillions in cuts to cherished social programs, thereby precipitating a game of chicken that would spook financial markets and torpedo our credit rating. Schumer has campaigned relentlessly for a “clean” debt-ceiling bill, bereft of any spending cuts, entitlement reforms, spending caps, or balanced-budget amendments whatsoever. Over 100 progressives in the House even called on the Democratic House leadership to “establish a Democratic position in favor of a clean extension of the debt ceiling.” President Obama concurred.
But things are different now. The warning from S&P, in particular, has established a much-needed floor to what the financial community expects from any increase in the debt ceiling. Should lawmakers aim too low, very real and serious consequences could ensue. CNNMoney elaborated on the reasoning behind S&P’s decision: “While S&P believes the U.S. economy is diverse and that the nation’s monetary policy is sound, the agency said a downgrade is possible if Congress and the Obama administration fail to enact a credible deficit reduction plan.”
Indeed, Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott, noted that S&P’s decision to cut the U.S. credit rating hinges on “whether Congress can cut the budget fast enough and big enough.”
A report from the Reuters News Service adds that Gross’s “more bearish” view of U.S. government securities stems from “his growing worries over the country’s fiscal deficit and debt burden.”
All this, of course, begs the question of what a “credible deficit reduction plan” would look like. Will the package Congress puts together be “big enough,” and will it be enacted “fast enough” to address these concerns? Thus far, there has been no discernible negative reaction in the markets, probably reflecting the conventional wisdom on Wall Street as articulated by Kevin Giddis, managing director of fixed income at Morgan Keegan: “The U.S. will continue to do what it takes to make sure there is enough money, enough debt, and enough liquidity to ensure economic growth while, over time, reducing the deficit.”
Yeah, don’t give him anything too good to hit. But don’t walk him!
#pageSpeaker John Boehner tried valiantly to clarify this ambiguity. “To increase the debt limit without simultaneously addressing the drivers of our debt,” he argued before an audience of financial movers and shakers at the New York Economic Club, “would . . . send a signal to investors and entrepreneurs everywhere that America still is not serious about dealing with our spending addiction.” He set forth several broad metrics by which to measure whether a plan to scale back federal spending is “serious” enough to satisfy the S&P test.
‐ Spending cuts must be measured in “trillions, not just billions” and must be “greater than the accompanying increase in debt authority” that Congress sends to the president.
‐ The cuts must be “actual cuts and program reforms” rather than “broad deficit or debt targets that punt the tough questions to the future.”
‐ Everything must be on the table, with the exception of tax hikes — which Boehner correctly believes would destroy jobs. Specifically, “honest conversations about how best to preserve Medicare” are necessary, “because we all know, with millions of Baby Boomers beginning to retire, the status quo is unsustainable.”
The one important thing missing from Boehner’s thoughtful speech was any reference to the need to maintain national-security spending at a level that guarantees that our military can fulfill its mission to safeguard Americans.
“If we don’t act boldly now,” he concluded, “the markets will act for us very soon. That’s the warning we got from Standard & Poor’s a few weeks ago.”
The Republican Study Committee has weighed in with the specifics for what it considers a “credible deficit reduction plan.” This group of conservative lawmakers calls for reforms and spending cuts, including cuts to entitlement programs, sufficient to improve the fiscal trajectory in the short, medium, and long terms. Specifically, the group calls upon Boehner to include:
‐ “Immediate spending cuts [reaching both discretionary and mandatory programs] . . . that would cut the deficit in half next year.” According to budget experts, this translates into $381 billion in cuts next year alone.
‐ A cap on federal spending set at 18 percent of the Gross Domestic Product (federal spending currently weighs in at approximately 24 percent of GDP) coupled with automatic spending cuts should Congress breach the cap.
‐ A balanced-budget amendment to the Constitution that both limits overall federal spending to 18 percent of GDP and protects against tax increases.
Senate Republicans are busy laying down their own floor. Minority Leader Mitch McConnell favors caps on both entitlement and discretionary programs. Significantly, he insists that reforms to both Medicare and Medicaid (though not Social Security) be part of the deal. Other senators, including Rand Paul (R., Ky.), Bob Corker (R., Tenn.), and Pat Toomey (R., Pa.), have released their own proposals.
The floor of expectations will rise each time those fiscal alarm bells ring.
Consider the latest report from the trustees of the fiscally troubled Medicare and Social Security programs. In just the last twelve months, they reported last Friday, Medicare’s fiscal hole worsened by an additional $2 trillion; Medicare’s projected date of insolvency is now 2024, five years earlier than projected last year. The news was similarly dour for Social Security, where expenditures exceeded payroll-tax receipts last year by $49 billion, and the date of insolvency edged another year closer, to 2036.
The findings in last week’s Bloomberg poll of investors illustrate the challenge Hill Republicans face. The GOP, it seems, has won the intellectual battle with this potentially important group of opinion leaders: 62 percent favor the congressional GOP’s position on spending cuts in the budget debate, while only 24 percent side with the president and his preference for tax increases. Yet, by a similarly lopsided margin, the same investors say they are resigned to hefty tax increases’ being part of any final budget deal.
We should expect more from investors and other opinion leaders. After all, this is the most important issue of our time. Rather than accept a slow, sclerotic American decline, they should demand that Congress — as Rep. Paul Ryan (R., Wis.) said in his speech to the Economic Club of Chicago — “put our budget on a path to balance and . . . our economy on a path to prosperity.” These twin goals go hand in hand. “Stable government finances,” Ryan continued, “are essential to a growing economy, and economic growth is essential to balancing the budget.”
The contours of the Republican side of the upcoming debate on the debt ceiling — spending restraint and economic growth — are now clear. What’s needed is an army of credible advocates who will get off the sidelines, discard their defeatism, and carry the intellectual argument for limited government forward in every venue big and small — before the next alarm bells go off.
— Michael G. Franc is the Heritage Foundation’s vice president of government studies.