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Senate Economist Warns Debt Limit Fight Could Raise Interest Rates

Treasury Secretary Jacob J. Lew has warned the debt limit must be raised by Nov. 5. (Tom Williams/CQ Roll Call file photo)
Treasury Secretary Jacob J. Lew has warned the debt limit must be raised by Nov. 5. (Tom Williams/CQ Roll Call file photo)

The White House push for a debt limit hike got some ammunition Friday from the chief economist for the Senate Budget Committee, who warned failure to increase the limit soon could cause interest rates to rise on newly issued federal debt.  

In a budget bulletin, economist William Beach, who formerly worked at the Heritage Foundation, warns the nation risks higher borrowing costs if it even gets close to exhausting the extraordinary measures used to avoid hitting the debt limit, now pegged by Treasury Secretary Jacob J. Lew as occurring on or about Nov. 5 , about a month earlier than expected. The new date has the effect of making it a must-do item for outgoing Speaker John A. Boehner, R-Ohio, as he goes about cleaning up a “dirty barn” for his successor. Options for Boehner include passing a straight-up debt limit hike, attaching it to a must-pass deal on transportation due by the end of the month, or some other combination. Tying it to anything opposed by President Barack Obama risks a default crisis given that Obama has repeatedly warned he will not pay a ransom again after agreeing to hand Boehner north of $2 trillion in spending cuts for a debt limit hike in 2011.  

Even a momentary failure to pay the nation’s debts could cause long-term increases in borrowing costs, Beach said, warning a mere technical error in 1979 caused a 60-basis-point hike in interest rates that persisted for nearly a year.  

Here’s the key portion of Beach’s report :

“New research from academics and the Government Accountability Office strongly indicates that the movement toward expiration is accompanied by an increase in the government’s cost of issuing new debt. It works this way: Securities brokers and money-market managers constantly create financial products that include relatively risk-free Treasury bills, notes, and bonds. These Treasury products serve as collateral or hedges in transactions that require an asset whose value is little affected by risk. For financial products that mature in or near the time when the federal government might not be able to pay all its bills, the Treasury asset no longer appears risk-free. Because it no longer has a more-or-less-certain value, brokers search for something else to anchor their products. As a result, the demand for Treasury products falls, and the yield that Treasury must guarantee buyers rises. This dynamic increases the costs to the Treasury, thus aggravating the nation’s fiscal condition.

These costs stem solely from the mere threat of default, but there are additional potential costs to be considered from an actual failure of the Treasury to service its debt or to pay its bills. The only Treasury default of the past 100 years, a technical default from late April through early May of 1979, demonstrates the risks involved. Word processing equipment at Treasury failed in mid- April of that year, which prevented the payment of interest on Treasury securities maturing at the end of the month. This purely technical default led to a 60-basis-point increase in Treasury interest rates, which lasted for nearly a year after the resumption of interest payments.

It is nevertheless reassuring that Treasury has so many debt-limit tools at its disposal and so much experience using them. As a result, U.S. citizens and foreign observers can be reasonably certain that every measure will be taken to pay the country’s bills on time. Indeed, the United States has a near-perfect record doing so even when borrowing authority has expired.”

Lew Warns Debt Limit Hike Needed by Nov. 5

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