Why is Everyone Afraid of the Debt Ceiling?

One of the things we keep hearing from “establishment” politicians, economists and others is that the US entered into the Great Abyss yesterday afternoon. “The sky is falling” they cry. “We’re doomed” they yell.

This guy is broke - and so are you!

You see, the United States of America just crossed the Rubicon. The debt ceiling – the amount of debt Congress authorizes the Treasury to accumulate – has been reached. The great fear is that the US government is about to default on our public debt, sending the world into an economic vortex never before witnessed. Every talking head and government official in DC is warning against not raising the debt ceiling. “We’ve never defaulted on our debt” is the common cry of alarm.

I would certainly be alarmed at this outcry, except for one thing. It isn’t true. Not a single word of it. In fact, the nation has defaulted on the debt at least twice in our history. The first was in 1790, when we couldn’t service the debt we accrued during the Revolutionary War, among other things. The second was in 1933.

In 1790, the Treasury realized it could not possibly repay the outstanding loans the Federal government assumed after the ratification of the Constitution. The solution was to unilaterally rewrite the terms of those loans, reducing the interest owed and deferring payments for ten years.

The scenario most applicable to today is the one enacted by FDR in 1933. The government, faced with a debt it could not repay unless taxes were raised to incomprehensible levels and wanting to inject some life (i.e, capital) into a lackluster economy, devalued the dollar by more than 40%. The problem was that US bonds were issued in gold: you bought x amount of bonds in dollars and in return you received y  amount of gold when the bond matured. The US didn’t own enough gold to cover the debt. The solution was Executive Order 6102, later codified as the Gold Reserve Act of 1934. It essentially confiscated all of the private gold holdings in the US (private citizens were allowed to have 5 troy ounces in their possession; or about $7500 worth in today’s standards).

The exact opposite of what we’ve been told by economists and politicians of all stripes happened: rather than market chaos and depression, the economy stabilized. Freed of the uncertainty spawned from over-indebtedness, the business community actually began expanding again. Yes, the Great Depression was so deep that it took additional government spending to make up for the slack in employment. But contrary to popular myth, it wasn’t the massive infusion of government capital with the outbreak of WWII that jolted the US to full productivity. By 1939, the nation’s economy was growing at 1928 levels again and by the end of 1940 had grown private sector employment to higher numbers than at the outset of the Great Depression. In fact, all of that debt from 1941-1945 precipitated a debt crisis in 1946 comparable to the one we’re now facing. Oh, and Congress took the appropriate actions then, too: they enacted a debt reduction plan that was adhered to by Presidents of both parties until LBJ’s “Great Society” spending in 1967.

Simply put: the US has defaulted on debt obligations before and the world went on as always. Look around you: the debt limit has passed, yet everything continues as on Monday. The real threat is that we continue to spend as profligately as a drunk sailor without any plan to tackle the debt. We can argue about the means to do so. We can inflate it away, as Russia, Argentina, Brazil – and the US in 1933 – did; we can unilaterally reorganize bond terms, as in 1790. We can reserve a greater share of federal revenues for debt service, as in 1946. We can even place tax increases and restructuring on the table. But scaring the citizenry about the implications of failing to to raise the debt ceiling is ludicrous, when raising the the ceiling is the most irresponsible thing the politicians now in Washington can do.