Economic Notes: Implications of Federal Government’s “Hitting the Ceiling”
7/27/2011
By Patrick O'Keefe, Director of Economic Research, J.H. Cohn
As the Federal Government has moved closer to its statutory debt ceiling (i.e., the total amount it may legally borrow), concern has grown as to the practical implications for businesses and households if policymakers fail to timely increase the limit.
The U.S. has approached its debt ceiling in the past but through various maneuvers was able to “buy time” until the limit was increased. Those maneuvers have been fully utilized and, therefore, barring an increase in the ceiling, the Federal Government is rapidly approaching its borrowing limit.
Since this has not happened before, we cannot be certain of the impacts of a failure to timely raise it. But there are some things we can reasonably expect.
To begin with, the partisan histrionics should be seen for what they are: attempts to gain political advantage, not efforts to inform the public.
Assuming the political posturing doesn’t spook the credit markets, the consequences of hitting the debt ceiling on the general economy will start small, but grow steadily as the impasse persists. (Even if financial markets were to remain relatively calm, interest rates can be expected to rise as the Treasury rolls-over maturing instruments.)
The immediate impact of hitting the ceiling is that Federal spending will be limited to the amount of revenue received. That will require the Federal Government to ration cash and, therefore, prioritize its disbursements. (A lot of bills will go unpaid since the Federal Government is currently borrowing about 40% of what it spends).
Although the Treasury Secretary has not disclosed the Administration’s priorities, it is reasonable to assume that the top three are: (1) debt service; (2) national security (viz., combat and intelligence); and (3) entitlements (e.g., Social Security, Medicare). The revenue stream is sufficient to cover those in the near term.
Beyond that, the Administration will determine the allocation of the remaining cash revenue, most likely through a combination of FIFO-disbursements to some “non-priority” contractors/grantees and furloughs of “non-essential” personnel, with the services they provide being suspended.
The Federal Government is a major purchaser of goods and services, as well as provider of funding to other levels of Government. Payments to many (if not most) of those providers and recipients would likely be delayed. If so, those doing business with affected providers/recipients may experience cash-flow disruptions.
Accordingly, businesses may wish to consider whether their cash flow depends on entities – including those at some remove in the chain of payments – whose income is derived from the Federal Government. And if so, assess the extent of that exposure; whether (and for how long) they can cover the gap from reserves or other sources; and develop contingencies to meet potential shortfalls.
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The statements, opinions, and conclusions contained herein are based solely upon the author’s own studies, research, and personal experience. Neither J.H. Cohn LLP nor the author makes any representation or warranty as to the accuracy or completeness of this information. J.H. Cohn LLP and the author expressly disclaim any liability for any loss or damage which may be incurred, of any kind whatsoever, as a result of or arising from the use of any of the information contained herein or reliance on the accuracy or completeness of it.
Patrick O’Keefe is director of economic research at J.H. Cohn. He can be reached at pokeefe@jhcohn.com or 1-877-704-3500.
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