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Bailing out Obama

At the White House and in talks in congressional offices and corridors, most of the attention was focused on finding a way to define the precise conditions under which the president could get a second increase in the debt limit that would be needed early in 2012 under both Republican and Democratic proposals.

– “Amid New Talks, Some Optimism on Debt Crisis,” The New York Times, July 30, 2011

It’s not hard to understand why the leaders of both political parties are vehemently opposed to the possibility of U.S. default. But as many commentators, including myself, have pointed out for weeks, a failure to raise the debt ceiling has absolutely nothing to do with the possibility of a sovereign U.S. default! In fact, raising the debt ceiling will make a default much more likely in the future. So why are the politicians, particularly Barack Obama, so desperate to see some sort of deal struck that will permit the raising of the $14.3 trillion federal debt ceiling?

I was recently asked to explain the situation to a mainstream news organization that was finding the argument between Obama and the Senate Democrats and the House Republicans to be more than a little confusing. They were right to be confused, because the debate between the nonexistent spending cuts of the Democrats and the fictional spending cuts of the Republicans are nothing more than political theatre put on for public consumption by the economically illiterate electorate. It makes absolutely no difference if the budget plan adopted was the Boehner plan rejected by the Senate, which contained $76.1 billion in average annual reductions in the amount of planned spending increases, (the Republican plan never contained any net spending cuts), or the compromise plan that is rumored to be in the works over the weekend.

Regardless of the final form of the 2011 budget, the outcome will be the same. A $1.5 trillion annual increase in federal borrowing and spending. The chart below shows why:

The Federal Reserve’s Z1 report reported an increase in the total amount of credit outstanding in the U.S. economy every single year from 1946 through 2008. It increased at an average rate of 9.2 percent per year and reached its all-time peak in the first quarter of 2009 at $52.9 trillion. Had it continued growing at its historical pace, it would have amounted to $71.2 trillion in the first quarter of 2011. Instead, it remained more or less flat at $52.6 trillion, as it had for the previous seven quarters. This is why the economy has appeared to be in a stagnant state, neither growing nor contracting, despite GDP figures and stock market growth which indicates economic recovery and unemployment figures that point towards continued economic recession.

However, the key word in that sentence is “appeared.” For in fact, while the overall amount of U.S. debt outstanding has remained essentially the same, the composition of that debt has changed considerably. Below is a chart that shows the way in which private debt has been increasingly exchanged for public debt since the third quarter of 2008.

In 2005, federal, state and local government debt amounted to 16 percent of total U.S. debt. In 2011, the government sector represents 23 percent of it. At roughly $525 billion per percent, this shows the $4.1 trillion in new debt that has been amassed by the Bush and Obama administrations since the autumn of 2008. This $4 trillion has just barely managed to replace the $3.6 trillion decrease in household and financial sector debt. The problem, of course, is that this substitution of government debt for private debt required to keep the economy out of free fall cannot continue without an increase in the debt ceiling. Hence the desperation to raise the ceiling on the part of Democrats and Republicans alike.

Based on the continued bad news out of the housing market, where prices and sales continue to decline, we can see that the government debt sector will have to continue increasing about $365 billion per quarter, or $1.5 trillion per year, to prevent the economy from getting any worse. This is why the number bandied about for the “necessary” compromise is $2.4 trillion – that is six quarters worth of continued borrowing at the rate required in order to continue the three-year game of extend-and-pretend. Of course, increasing the total federal debt by nearly one-fifth will only make things that much worse for the American people in 2013; but then, either Obama will not need to face re-election again or it will be someone else’s problem.

Raising the debt ceiling will not help Republicans regardless of how the tea party responds to the betrayal of their 2010 mandate to stop government spending, because it is nothing less than a bailout of the Obama administration. An increase in the federal debt limit does not ensure Obama’s re-election, but it renders it possible by delaying the inevitable economic crash that would otherwise ensue.