However, the fiscal cliff is the lesser of two approaching crises; the other crisis is more potentially damaging and, ironically, more easily avoidable: a first-ever default by the U.S. government on its bill-paying obligations, should Congress fail to raise the federal debt limit in the next few months. The figure below shows how close the federal debt has come to the debt limit, as of .
Both of the approaching crises — the fiscal cliff and the default threat — would be triggered by government’s failure to take action. The fiscal cliff entails near-instantaneous tax hikes and spending cuts that experts say would be too much, too fast, too arbitrary, and too soon. But a first-ever default (resulting from failure by Congress to raise the statutory debt limit) would be worse, because it would force much larger instantaneous spending reductions — mostly in critical big-ticket categories such as Medicare, Social Security, defense, and — worst of all — interest on the debt, which would be the doomsday scenario of self-inflicted national bankruptcy.
If the fiscal cliff’s “hard landing” scenario would be a disaster, default would be suicide. Failure to raise the debt limit in time to prevent default would not only create fiscal havoc internally, it could trigger an unraveling of the world’s confidence in the U.S. dollar and its Treasury securities. Because the dollar is the world’s preferred reserve currency, the “dollar economy” currently extends far beyond U.S. borders. If worldwide confidence in the dollar began to erode, foreign countries’ desires to roll their maturing U.S. debt securities into new ones would erode as well, which would only compound the negative consequences for our economy.
Figure 1: Excerpt from Daily Treasury Statement, November 13, 2012
The current, obsolete debt ceiling is set at a specific dollar level: “X trillion dollars” of debt — similar to setting a mileage limit for a car, which forces a hard stop when the odometer reaches some arbitrary number. A new, better way to limit the debt would be to switch our focus from the odometer to the speedometer, i.e., to set a target ratio for debt relative to the size of our economy — “X percent debt-to-GDP.” A car’s speedometer helps us keep miles-per-hour under control; a new measure for the debt limit would help us keep debt-to-GDP in bounds. It would create new incentives for lawmakers: all of a sudden, a “new” way to stay under the debt limit would be to implement growth-friendly laws and policies that help the economy grow faster than the debt grows.
In short, the dollar-level debt ceiling is obsolete, because it continues to invite politicians to flex their political muscles by threatening default. What we need now is a percent-GDP ceiling — perhaps dubbed the “debt guardrail” — that invites our politicians to foster private sector growth by showing us they can also flex their brain power, instead of just their political muscle.
Steve Conover retired recently from a 35-year career in corporate America. He has a BS in engineering, an MBA in finance, and a PhD in political economy. His website is .