10 things you should know about the American debt ceiling

ObamaVivek Kaul 
The American government is staring at a big problem ahead. Come October 17, and it will hit the debt ceiling set by the American Congress. If this happens it will have global implications. Given that, it is important to understand what the debt ceiling really means and how it can impact the whole world.
So what is the debt ceiling?
The American government, like almost every government in the world, spends more than what it earns. The difference between what it spends and what it earns is met through borrowing money. There is an overall limit to the amount the American government can borrow. This limit is currently set at $16.69 trillion.
So what will actually happen on October 17?
The American Treasury Secretary Jack Lew (equivalent of the finance minister in India) has said that on October 17, the Treasury department will run out of the extraordinary measures it had put in place to ensure that the government doesn’t cross the debt ceiling of $16.69 trillion. 
Since May 2013, Lew has taken a number of extraordinary measures, like delaying pension fund payments, to ensure that the government expenditure remains under control and hence, the government does not cross the debt ceiling.
So the American government will run out of money on October 17?
The answer to this question is not very clear. Lew has said that as on October 17, the government “
“will be left to meet our country’s commitments at that time with only approximately $30bn.” And this amount will not be enough to meet expenditures of the government, which on certain days can be as high as $60 billion. He has not clarified the exact expected expenditure of the American government as on October 17. Hence, we don’t know if the American government will run out of money on October 17.
So when will the American government actually run out of money?
There are various estimates going around on this. Most analysts agree that the government won’t run out of money on October 18, and will keep chugging along for a brief while. The Bipartisan Policy Center expects this date to be anywhere between October 22 and November 1. 
As it points out “Updated data on Treasury cash flows through the first week of October show that the range for the Bipartisan Policy Center’s (BPC) X Date – the date on which the United States will be unable to meet all of its financial obligations in full and on time – has narrowed to between October 22 and November 1.”
Economists at JP Morgan have come up with a more precise date of October 24th. 
As an article on Time.com points out “They (i.e. the economists at JP Morgan) write that it is “extremely unlikely” the Treasury will be able to make it’s payments more than a few days after the 24th, and that the Treasury would most certainly have to default on some payments by November 1st, when large outlays for Social Security, Medicare, retirement benefits for military and civil services workers, and interest payments are due.”
So what will be the impact of this?
The expenditure of the American government will be greater than its income. Until now it has been able to borrow money to finance the gap. It won’t be able to borrow anymore. Given that, it will have to cut down on its expenditure.
AsEric Posner writes on Slate.com “If the debt ceiling is not raised, and the executive branch stops borrowing, the government will need to cut spending by about 15 to 20 percent—or almost 40 percent of spending on everything (yes, Medicare and defense) other than the interest on the debt.”
The impact of the cut in expenditure will be immediate. As Henry J Aaron writes in The New York Times “A decision to cut spending enough to avoid borrowing would instantaneously slash outlays by approximately $600 billion a year. Cutting payments to veterans, Social Security benefits and interest on the national debt by half would just about do the job. But such cuts would not only illegally betray promises to veterans, the elderly and disabled and bondholders.”
Other than having economic consequences, this cut in expenditure will also have social consequences. As Mark Blyth writes in 
Austerity – The History of a Dangerous Idea in a slightly different context but still applicabl in this case, “Seventy-two percent of the working population(in America) live paycheck to paycheck, have few if any savings, and would have trouble raising $2000 at short notice. There are, as far as we can tell, about 70 million handguns in the United States. So what would happen if…no paychecks were being paid out?”
Hence, cutting expenditure can have dramatic social and economic consequences.
So why is the American government doing nothing about this?
As must be clear by now the consequences of the American government hitting the debt ceiling and not being able to meet its expenditure, will be disastrous. Given this, why hasn’t the government done something about it? Why haven’t they increased the debt ceiling?
The answer lies in the fact that the two houses of the American Congress are currently in a logjam. The House of Representatives is dominated by the Republican Party and the Senate is dominated by the Democratic Party. And both the parties are refusing to talk to each other. The Republicans believe that fiscal profligacy of the American government has gone on for too long and needs to be reined in.
In fact, many Republican Congressmen are not concerned about the debt ceiling at all. 
As Senator Richard Burr recently said I’m not as concerned as the president is on the debt ceiling, because the only people buying our bonds right now is the Federal Reserve. So it’s like scaring ourselves.”
So are Republicans right on only the Federal Reserve buying government bonds?
This statement has been true in the recent past. The Federal Reserve of United States, the American central bank has been printing money to buy American government bonds. This helps the government finance its fiscal deficit. Fiscal deficit is the difference between between what a government earns and what it spends.
But Burr’s statement does not take into account the fact that foreign countries hold nearly $5.6 trillion of American government bonds. In comparison, the treasury holds bonds worth $1.93 trillion. These bonds were issued by the American government to borrow money to finance its fiscal deficit.
Interest on these bonds needs to be paid. Also, maturing bonds needs to be repaid. The American government has reached a stage, where it pays the interest on bonds as well as repays maturing bonds, by raising money by selling new bonds and taking on more debt. Any decision to stop paying interest on bonds or default on maturing bonds, will lead to a global financial crisis. As Posner writes “ If he(i.e Obama) stops interest payments, the United States will default. This will not only raise interest payments—costing taxpayers hundreds of billions of dollars—but could spark a financial panic like the meltdown of 2008.”
The US government bonds are the ultimate risk free asset. If the government defaults on interest payments and/or principal repayment, then investors all over the world are going to exit all kinds of financial markets. No wonder China which holds more than a trillion dollars of American government bonds is worried. 
The Chinese Vice Finance Minister Zhu Guangyao recently said “We naturally are paying attention to financial deadlock in the U.S. and reasonably demand that the U.S. guarantee the safety of Chinese investment there.”
So that brings us back to the question why aren’t Republicans and Democrats talking?
This basically boils down to the fact that Republican Congressmen seem to be confident that the government is in a position to work its way around the debt ceiling. As Senator Orrin Hatch recently said “I think the administration could work on who gets paid and who doesn’t in a way that would pull us through.”
It is easy to ask the government to prioritize payments, but anything done around those lines could have serious legal implications. It needs to be pointed out that there are no legal provisions to decide which expenditure should be cut first. “There is no clear legal basis for deciding what programs to cut. Defense contractors, or Medicare payments to doctors? Education grants, or the F.B.I.? Endless litigation would follow. No matter how the cuts might be distributed, they would, if sustained for more than a very brief period, kill the economic recovery and cause unemployment to return quickly to double digits,” Aaron points out in 
The New York Times.
The politicians on both the sides are also taking it easy because the markets haven’t reacted to this lack of communication between the two political parties on the debt ceiling. As Senator Hatch put it “I don’t think the markets have been spooked so far, and I personally believe that if they realized there was a legitimate attempt to make the government work, they would be less likely [to be spooked].”
So why haven’t the markets reacted?
The debt ceiling has been in place since 1939. And since then the American Congress has raised it numerous times to allow the government to borrow more. As an article in the Christian Science Monitor points out “An overall cap on federal debt has been in place since 1939, and Congress has raised it numerous times since then. The Treasury Department counts 78 times since 1960.”
What has happened 78 times is also likely to happen one more time.
This explains why the various financial markets in America and around the world continue to remain stable and are not taking into account the possibility of another crisis. As Bill Gross manager of the world’s biggest bond fund, told Bloomberg Television “The odds of a default are “a million-to-one” as the Treasury Department will be able to take other measures to ensure it is servicing the country’s debt.”
Hence, the market is currently expecting the Republicans and the Democrats to sit down and solve the problem before October 17.
So will the markets continue to remain stable?
That’s a tricky question to answer. The closer we get to October 17 without any solution in sight, the more the stability of the markets will be threatened. In fact, if the American stock market falls it might even get the Republicans and the Democrats to start talking. As John Cassidy of The New Yorker magazines writes on his blog “If the market fell by, say, three or four hundred points for three days in a row, and then lurched down another eight hundred points, or even a thousand points, the effect would be salutary. How can I say that? Tens of millions of Americans would grow alarmed about their 401k plans. On Wall Street, there would be margin calls, liquidity runs, and other disturbing developments that inevitably accompany market breaks. Rumors would start to spread about the health of various financial institutions. You don’t have to subscribe to a tail-wags-the-dog view of finance and politics to believe that this would lead to a rapid change of thinking, and of behaviour, in Washington.”
This will get the two sides talking on the debt ceiling for sure.

The article originally appeared on www.firstpost.com on October 9, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek) 

The $1 trillion coin: Krugman’s loony idea to save US

platinum_coinVivek Kaul
When the going gets tough, the ideas get absurd and bizarre. No one said that. I just happened to ‘coin’ it after coming across one of the craziest things I have heard in recent times. It all about ‘coining’ a trillion dollar platinum coin that could ‘supposedly’ solve one of the biggest financial problems of our times. But before we get to that some background information is required here.
The American government cannot print money
The budget deficit of the American government has been greater than trillion dollars for the last four years. Budget deficit is the difference between what a government earns and what it spends.
In order to finance this deficit the American treasury department (or what we call the ministry of finance in India) borrows money. But there is only so much money going around to be borrowed. And with trillion dollar deficits borrowing beyond a point is not possible.
So what does the government do? Common sense tells us that it can print dollars and finance the deficit. But the American government is not allowed to print money. Instead it borrows from the Federal Reserve of the United States (the American Central bank or what we call the Reserve Bank of India).
Now where does the Federal Reserve get money to lend to the government? It simply prints it. The Federal Reserve as the central bank is allowed to print money. As John Truman Wolfe author of Crisis by Design: The Untold Story of the Global Financial Coup puts it “How bizarre is it that instead of simply printing the money themselves, governments “chose” to borrow it from their respective central bank. The US is currently $16 trillion in debt – and the debt is growing at the rate of $49,000 a second! Last year’s interest on the debt here was $454,000,000,000 – Why borrow money from the Fed (who simply creates it out of thin air by making a book entry and clicking a mouse ) when the government could simply print its own without borrowing it and paying interest on it.”
The debt ceiling
There is a ceiling to how much the American government can borrow and it is $16.4trillion. This was breached on December 31, 2012. After this the treasury secretary Timothy Geithner put in place some “extraordinary measures” that will give a headroom of round $200 billion and help the American government avoid a default on its maturing debt as well as continue meeting its various expenditures. The American government has reached a stage where it has to take on more debt to pay off previous debt. But with the debt ceiling being hit more debt cannot be taken on. The American politicians have been unable to find a solution to this till date.
The loophole
The US Code Section 5112 states this:
“The (Treasury) Secretary may mint and issue platinum bullion coins and proof platinum coins in accordance with such specifications, designs, varieties, quantities, denominations, and inscriptions as the Secretary, in the Secretary’s discretion, may prescribe from time to time.”
The above section basically allows the American Treasury Secretary to mint absolutely any kind of platinum coin. When it comes to gold and silver coins, he is not allowed such a leeway. The Code prescribes the exact dimensions as well as weights of gold and silver coins that can be minted. In case of platinum coins no such prescriptions are made.
So what is the idea?
This loophole allows the Treasury Secretary of the United States to get the US Mint to mint a platinum coin and deem it be worth $1trillion (or any big amount for that matter). The amount of platinum in the coin doesn’t really matter. It could be one gram or one troy ounce (28.31 grams). Hence the face value of the coin (i.e. $1trillion) would have no link with the amount of platinum in it.
Having minted such a platinum coin, the Treasury Secretary can then use the coin to repay the money that it has borrowed from the Federal Reserve. The Federal Reserve would have to accept the coin simply because any creditor cannot refuse what is legally deemed to be money, when it comes to the settlement of a debt. And the $1trillion coin would be a legal tender.
Once the $1 trillion coin is presented to the Federal Reserve, the total debt outstanding of the American government would come down below the debt ceiling of $16.4trillion. As on January 2, 2013, the American government had borrowed around $1.67trillion from the Federal Reserve. And that way the American government could continue to borrow more.
The Krugman push
The Nobel prize winning economist Paul Krugman gave a push to the idea by recommending it on his blog a couple of days back. Krugman feels that even though the idea is silly it makes sense simply because the US Congress has the right to approve the spending bills but then it won’t let the President to borrow money required to implement those bills.
As Krugman wrote “we have the weird and destructive institution of the debt ceiling; this lets Congress approve tax and spending bills that imply a large budget deficit — tax and spending bills the president is legally required to implement — and then lets Congress refuse to grant the president authority to borrow, preventing him from carrying out his legal duties and provoking a possibly catastrophic default.”
There are others who do not buy the idea at all. As Kevin Drum, a famous blogger, wrote recently “Is this really the road liberals want to go down? Do we really want to be on record endorsing the idea that if a president doesn’t get his way, he should simply twist the law like a pretzel and essentially do what he wants by fiat?”
The big danger in this case is that if something like this were to be implemented, the American government can easily keep getting the Federal Reserve of United States to keep printing money and keep repaying that money through issuing one trillion dollar platinum coins. That cannot be a good idea after all. A government which has the power to print unlimited amount of money, even though indirectly, is not something that world wants, specially given that the dollar continues to be the international reserve currency.
To conclude, it is ‘absurd’ ideas like these that make me remain bullish on gold despite the recent attempts to discredit the yellow metal as being useless.

The article originally appeared on www.firstpost.com on January 9, 2013
(Vivek Kaul is a writer. He can be reached at [email protected])