Most of us are not professional economists and when we hear politicians saying that maybe a government shut down and debt default is a good thing, we don't have the background to understand what would really happen in such a situation. It sounds good in a 30 second sound-bite, but what are the realities? How will you and I be affected?
To find out exactly what a refusal to increase the debt ceiling would mean to the average American, I spoke with Dr. Memo Diriker, who has 25 years of experience in economic forecasting, is a professor at Salisbury University's Franklin P. Perdue School of Business, Director of the Business, Economic and Community Outreach Network, and author of "Europe, Inc.: Wake up America -- Move Over Japan -- the Europeans are Coming!"
If the debt ceiling is not raised, is it necessarily true that the United States will default on its debt obligations?
Diriker: Well, the government owes money and makes payment to many different groups of people, there are social security checks, bond-holders, and many other kinds of obligations. In that mix, there won't be enough money to pay them all. The expectation is that there will be cuts to payments to debt-holders as well as individuals and others that the United States usually cuts checks for. What mixture that is going to take, nobody knows. I'm sure there are contingency plans being looked at within the government, but they have not been announced. The expectation is that the majority of it would be on the bonds.
Is that something President Obama and the Treasury have to decide or does congress have a say?
Diriker: No, congress does not have a say, because it is an administrative function. The President, the Treasury, and various department heads will have to decide whose checks are going to be cut and whose are not.
So President Obama could decide that the very first expense to be cut is congressional salaries?
Diriker: Ha! Of course he can. That would be interesting!
If the debt ceiling is not raised, what are the immediate effects that would be felt by the average American citizen?
Diriker: The biggest question mark is what happens to interest rates, because, if you look at the various scenarios that economists are applying within their simulations, one of the most likely outcomes is that interest rates will go up. The rating agencies will say that the full faith and credit of the U.S. government is not worth as much as it was. Therefore, investing in the United States government is a risky proposition, so we'll demand higher interest rates if you want our money. That will have a domino effect with interest rates going up. In the meantime, as soon as the key interest rates go up, all the interest rates on our credit cards, our adjustable rate mortgages, everything is linked to that, so the domino effect will take over. Essentially, the amount of money available to us, to borrow, to pay our credit cards, everything will be affected.
If we go into default and interest rates rise, what would be the effect on the overall economy at this point?
Diriker: Well, already even though housing prices are low, it's difficult to get loans, because they are requiring a lot better credit ratings. They are requiring bigger down payments. The only thing that is going for you is lower interest rates and low house prices. If you add higher interest rates, the value of houses drops even further. This is our piggy bank. This is our biggest investment. So, if we can no longer have value in the house that we live in, people who paid $450,000 cannot sell for $200,000. So if you are depressing the value of homes, if you make it harder for people to buy homes, then that's definitely a trigger for a double-dip recession. Add, on top of that, the impact on credit cards, that I can no longer spend what I am used to borrowing, because we are the most indebted nation as individuals. We use plastic more than we use cash, and suddenly we're not going to be able to use it, that's another double-dip recession trigger.
That's why I am so scared. There are so many double-dip recession triggers in this. Even if what the freshman Republicans want comes to pass and the Administration agrees that we are going to do big cuts, no taxes, that, too, is a double-dip recession trigger, because you are taking massive amounts of money from the economy very quickly.
On the other hand, is it almost a wash where the government is not taking in the money, but we're not paying it out either? Is it just a reshuffling of accounts?
Diriker: On paper it's a wash, but in reality, where the money is in different silos and people are actually using that money for something, you can't say that.
In this case, the people who would be using that money include recipients of social security checks, military pay checks.
Diriker: Exactly. The question is who's going to be losing and how much. If, on one hand, they were able to divorce the two prospects, the debt ceiling '"The technical thing '" from the long term solution to the problem of debt and spending, that's what we all need as a nation, but unfortunately, so close to a presidential election and in such a contentious situation, everything is political.
Obviously, the freshman Republicans are very aware that they are holding a very important key and they're going to make it work for them as much as they can.
We've talked about the possibility of a double-dip recession. That would increase unemployment even beyond where it is now.
Diriker: Yes.
Can you estimate what it might reach?
Diriker: Well, some economists predict real unemployment to be a high as 18 percent --
That's right now.
Diriker: Yes. When you look at the people who have decided not to go back to work, or have decided to go back to school, retire, take part-time jobs, et cetera, the de facto actual unemployment is close to one in five people. I can imagine that becoming as high as 25 percent. It's a truly catastrophic scenario, but it is possible. What other thing do we have on the horizon that says there's going to be a big need for people?
We do have a skill gap. There are certain jobs that we don't have the skilled people for them. So you might find a very awkward situation of having to import immigrants who are sufficiently qualified to take on those jobs while we tell our own citizens "sorry, we're not going to have any jobs for you." Talk about social strata.
Is there something else we should bring out in this conversation?
Diriker: No, but, I don't care what you faith is, this is a time for reflection and prayer, I think.
Conclusion
We'd all like government spending to go on a diet, but just as in the real world when you suddenly go on a complete starvation diet, bad things happen. You lose strength, you lose energy, and you tend to rebound into even worse shape than you were in before you started. The American economy can't afford to lose energy or strength right now, and we certainly can't afford to rebound back into a double-dip recession.
We need to take care of our country and our economy first by raising the debt ceiling, not just for six months, but for a period long enough to restore some predictability and stability to the bond markets. We also need to embark on a measured course of shared sacrifice to reduce government spending for the long haul. Unlike some, the American people are not just invested in the economy until November 2012 and we're not looking for the latest fad spending diet. We want a lasting change, brought about in an orderly manner without risking the health of our nation.
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