Political leaders in Washington, D.C., are at an impasse over raising the country’s debt ceiling, the congressionally imposed limit on government borrowing that is on schedule to be reached Aug. 2.
Unlike some Washington debates, though, this is an issue that could have real and immediate impact on everyone’s lives.
If Congress fails to raise the debt ceiling by the Aug. 2 deadline, the stock market could tumble and interest rates could rise. But spending cuts or tax hikes in such a deal could themselves hurt the economy -- or energize it, according to local financial planners and bankers.
“We’ve never been there before,” said Rick Kahler, president of the Kahler Financial Group. “We’re going to have to guess and wait and see.”
With the deadline approaching, new developments are occurring every day. On Tuesday, Senate Minority Leader Mitch McConnell suggested that an agreement was impossible and floated a proposal to let President Barack Obama increase the debt limit himself by up to $2.5 trillion if he offsets it with spending cuts.
Democratic officials who participated in the session said Obama did not reject the Senate Republican leader's suggestion, but emphasized it was not his preferred approach. A statement issued later in press secretary Jay Carney’s name said the president "continues to believe that our focus must remain on seizing this unique opportunity to come to agreement on significant, balanced deficit reduction."
Obama, for his part, suggested Tuesday that if Congress misses the deadline, he “cannot guarantee” that the federal government could pay Social Security benefits.
Causing the problem is the federal government’s persistent deficits. Spending has outpaced revenue for the past decade, with the most recent deficits equaling 10 percent of the entire economy. If current policies don’t change, the national debt is projected to increase from around 60 percent of the economy to almost 150 percent of the economy by 2030.
Local financial experts say a failure to reach a deal by Aug. 2 won’t be an immediate economic catastrophe.
“The government wouldn’t default,” said John Hanson, executive vice president at Black Hills Community Bank.
Unlike a true default, in which the government declares that it won’t pay a portion of its debts, failure to raise the debt ceiling will likely mean the government delays payment on its obligations. That could mean holders of government debt don’t get their payments right away, or it could mean a partial government shutdown as other federal spending ceases -- such as Social Security checks, as Obama suggested Tuesday.
“It’s a case of who do you believe?” said Kahler. “There are those that are saying they’ll stop sending out Social Security checks, the markets will go into a tailspin. There’s others suggesting that’s a lot of scare talk, that none of that will happen.”
Economist Don Frankenfeld believes the immediate impact of the country hitting the debt ceiling will be “somewhat remote” -- but “the stock market is likely to take a dive.”
Kahler agreed and said that savvy investors should see such a stock market drop as a buying opportunity if other investors panic and sell.
The day after the country hits the debt ceiling, Kahler said, all the fundamentals of the economy will still be the same.
“What’s really changed?” he said. “It could give us a good chance to buy some bargains.”
Interest rates are also likely to increase if the U.S. government stops borrowing money.
“When money becomes tight, interest rates rise,” Hanson said. “We all compete for the money.”
That means people looking to borrow money to buy a home or start a business will pay more for their loan -- if they can even get one. Kahler said banks expecting to receive payments from the federal government could find themselves in a credit crunch and scale back lending.
“If I was buying a house, I’d lock in the rate today,” he said.
But even if Congress reaches a deal to raise the debt ceiling, there will be economic impacts. Continued deficit spending could have a “crowding-out” effect on private investment.
“The credit of the government is better than the credit of private investors. Everyone else is necessarily down the line … when the money window opens,” Frankenfeld said. “Crowding-out is a problem, and the effect of crowding-out is a larger federal government and a smaller private sector.”
But efforts to end the deficit can also impact the economy.
“If we balance our budget today, which means we cut $1.5 trillion in spending … we will absolutely have another recession,” Kahler said. “You can’t take that spending out of the economy and not feel it.”
Balancing the budget in one fell stroke through tax increases would have a similar effect, he said.
Most proposals being discussed at the federal level involve less drastic cuts, on the scale of $200 billion or $400 billion per year over a decade.
But sharp reductions in the country’s deficit could also benefit the economy, by opening up more space for private businesses and ending uncertainty about the country’s fiscal future.
“The accumulation of debt is … scaring the capital markets and the private sector,” Kahler said.
In the long run, experts are unanimous that massive deficits need to end.
“That is our prescription for prosperity,” Frankenfeld. “But … in the long run, we’re all dead. We need to worry about the long run, but we need to worry first about Aug. 2.”
The Associated Press contributed to this report
Contact David Montgomery at 394-8329 or email@example.com