Risk of Inaction

What is the Real Threat? Inaction.

To achieve a balanced budget in eight years, the One Cent Solution, embodied in the “Penny Plan” legislation, requires that programs across the board are all “on the table.”

Critics suggest that cutting federal spending is unrealistic and puts at risk benefits under Social Security, Medicare and other federal programs.

But the real risk is inaction.

With approximately $10 trillion in outstanding public debt and a projected deficit of $1.5 trillion in 2011, the U.S. Treasury will need to borrow hundreds of billions of dollars per month from now on just to keep the government running.

While the Treasury should be able to continue borrowing at that rate for the next couple of years, the time is approaching when our lenders will simply stop lending, or they will raise interest rates to levels our government will no longer be able to afford to pay.

When that happens, the government will be unable to live up to its obligations under Social Security, Medicare or any other federal program, and we will find ourselves in a full-blown crisis.

No one knows when the crisis will occur, but most experts agree that the longer Congress fails to take action, the more quickly it will arrive. According to the Congressional Budget Office:

The exact point at which such a crisis might occur for the United States is unknown, in part because the ratio of federal debt to GDP is climbing into unfamiliar territory, and in part because the risk of a crisis is influenced by a number of other factors, including the government’s long-term budget outlook, its near-term borrowing needs, and the health of the economy. When fiscal crises do occur, they often happen during an economic downturn, which amplifies the difficulties of adjusting fiscal policy in response.

If the United States encountered a fiscal crisis, the abrupt rise in interest rates  would reflect investors’ fears that the government would renege on the terms of its existing debt or that it would increase the supply of money to finance its activities or pay creditors and thereby boost inflation. To restore investors’ confidence, policymakers would probably need to enact spending cuts or tax increases more drastic and painful than those that would have been necessary had the adjustments come sooner.

The Committee for a Responsible Federal Budget recently outlined several paths a fiscal crisis could take, ranging from a gradual approach that sees our long-term economic prospects slowly strangled by debt and interest payments, to a sudden crisis in which Americans wake up to discover a very stark, new economic reality.

According to one expert, the most likely trigger for a debt crisis would be a downgrading of the federal debt, which would send a shockwave throughout the entire financial industry. Interest rates would rise, banks would see their capital reserves downgraded, and corporate and individual investors will be faced with punishing margin calls.

These actions would force another round of restructuring. Banks would pull back on lending at the same time corporations and other investors seek credit to build up their balance sheets.

The result would be a credit crunch on a scale much greater than the one we have experienced during the most recent recession. Families and businesses would lose the ability to borrow and the economy would slow to a crawl. Slower economic growth, in turn, will reduce federal revenues, resulting in higher deficits and lower bond ratings.

How will it impact your daily life? It’s not a pretty picture.
Imagine driving to the grocery to get bread and other essentials, but the shelves of the store are picked clean because the store has lost the line of credit it uses to purchase its inventory. You then travel to the gas station to fill up, but there’s no gas. Without credit, the gas station owner was unable to fill his tanks.

The “For Sale” sign you have had in your front yard will be there for much longer, because with interest rates high and rising, and banks pulling back on their lending, finding a qualified buyer is now next to impossible. Because of the credit squeeze and the rise in interest rates, many of your neighbors can no longer make their mortgage payments. They will soon put their homes on the market, causing the value of your home to drop quickly.

And the value of your retirement account sinks by the day.

At home, you turn on the news and learn that Congress has just enacted an “Emergency Deficit Reduction Act” to address the fears of creditors and the financial markets. Because it failed to act sooner, spending reductions make up only a small part of the package. It takes time for spending cuts to take effect, and Congress doesn’t have time. In their place, your taxes are going up. Way up.

You call your spouse and decide to cancel this year’s vacation and use the money to pay down your credit card debts instead. After all, the interest rates have become unaffordable, and with your taxes going up, something has to give.

Other families do the same, and the resort you booked goes out of business, causing several hundred people to lose their jobs and apply for unemployment benefits. As this occurs across the nation, the cost of the federal government’s safety net explodes, putting even more pressure on the deficit, interest rates, and the government’s ability to borrow.

So when you hear critics claim the One Cent Solution, or the “Penny Plan” legislation, threatens important federal or entitlement programs, ask them how they would recommend avoiding our looming economic crisis. It’s real, and absent a plan that works, its arrival grows closer every day.

Inaction is the real threat to programs like Social Security and Medicare.

The One Cent Solution is the answer.