In a recent Gallup survey, 47% of Americans said they don't want the debt ceiling raised.
In separate -- but I think highly correlated -- surveys, nearly half of Americans lacked basic knowledge about interest rates, and 51% don't know what a credit freeze is.
Regardless of how you feel about the debt ceiling, here's what UBS senior economist Drew Matus thinks could happen if it's not raised:
The main impact on markets would come from sharply reduced liquidity in the U.S. Treasury market, as financial firms' procedures and systems would be tested by the world's largest debt market being in default. Given the existing legal contracts, trading agreements, and trading systems with which firms operate, could U.S. Treasurys be held or purchased or used as collateral? The aftermath of the failure of Lehman Brothers should be a reminder that the financial system's "plumbing" matters. All the legal commitments and limitations in a complex financial system mean a shock from an event that is viewed as inconceivable -- such as a U.S. Treasury default -- can cause the system to stall. The impact of a U.S. Treasury default could make us nostalgic for the market conditions that existed immediately after the failure of Lehman Brothers.
I don't know how anyone can argue that not raising the debt ceiling and letting the Treasury default would be anything but calamitous. The closest I've seen comes from hedge fund manager Stanley Druckenmiller, who argued that missing a few interest payments is preferable to not getting federal spending under control.
But this would only be true for long-term debt holders whose only immediate risk is interest payments. For short-term bond holders who might face a delay in principal repayment, a Treasury default could sap liquidity and push the financial system into a cascade of default.
If I owe you $100, and I plan on getting that $100 from the proceeds of Treasury securities that are about to mature, and suddenly the government delays repaying those securities, then I'm defaulting on you. That's when things start to spiral.
What killed Lehman, after all, wasn't its long-term holdings. It was the loss of its short-term financing. Bank of America
But let's focus on the issue at hand: the deficit. You can't blame people for not wanting the debt ceiling raised amid trillion-dollar deficits. But understanding the cause of those deficits is vital. David Leonhardt of The New York Times put it best:
Eventually, the country will have to confront the deficit we have, rather than the deficit we imagine. The one we imagine is a deficit caused by waste, fraud, abuse, foreign aid, oil industry subsidies and vague out-of-control spending. The one we have is caused by the world's highest health costs (by far), the world's largest military (by far), a Social Security program built when most people died by 70 -- and to pay for it all, the lowest tax rates in decades.
Here's what this looks like in terms of spending:
Total Federal Outlays (in billions)
Percent of Total
|Commerce and housing||$17||<1%|
|Undistributed offsetting receipts||($90)||(2%)|
Source: Office of Management and Budget. *Unemployment benefits, food stamps, etc.
Source: Office of Management and Budget.
To extend Leonhardt's point, the biggest hurdle to raising the debt ceiling may be overcoming misconceptions about the deficit. For example, the hugely powerful AARP just released an ad claiming:
If Congress really wants to balance the budget, they could stop spending our money on things like a cotton institute in Brazil; poetry at zoos, and treadmills for shrimp. But instead of cutting waste or closing tax loopholes, next month Congress could make a deal to cut Medicare -- even Social Security.
But that's deeply untrue. You can't balance the budget simply by cutting waste in discretionary spending. Even if all discretionary spending were eliminated, the deficit would still be several hundred billion dollars a year. The only way to balance the budget on the spending side of the ledger is to focus on the top few lines of the table above. That means big cuts to defense, Medicare, Social Security, and unemployment benefits -- all of which are massively popular and political dynamite to even mention.
Then there are taxes, which are more prone to hysteria and controversy than any kind of spending. There are really two groups in the tax debate. One says current taxes are crushingly high. The other says they're the lowest in modern history. It's possible for both to be right, but the chasm of disagreement on taxes is so wide that one has to think major tax compromises are off the table in the debt-ceiling debate. The dispute right now isn't even over what's right. It's over what counts as a fact. That's when you get nowhere.
By Aug. 2, the day the Treasury will default without raising the debt ceiling, one of four things will likely have happened. The first is a short-term extension of the debt ceiling without any changes to spending or taxes -- the kick-the-can-down-the-road solution. Second is huge cuts to social programs that curtail the deficit but are so unpopular that they likely get overturned. Third is a compromise of modest spending cuts and tax hikes to make the deficit more manageable over the next decade. Fourth is default.
What do you think should happen?
Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.
Fool contributor Morgan Housel owns B of A preferred. Follow him on Twitter @TMFHousel. The Motley Fool owns shares of JPMorgan Chase. The Fool owns shares of and has opened a short position on Bank of America. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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