By Professor Ricardo Ulivi, Ph.D.
The Federal government and Congress will soon meet again, at sundown, and draw guns on the issue of whether or not to increase the debt ceiling. What do you think will happen? What will be the consequences of a yes or no vote?
The Treasury Department today warned that “A default would be unprecedented and has the potential to be catastrophic . . . Credit markets could freeze, the value of the dollar could plummet, US interest rates could skyrocket, the negative spillovers could reverberate around the world, and there might be a financial crisis and recession that could echo the events of 2008 or worse.” Talk about a dire warning!
On the other hand, what would happen if Congress gives authority to raise the debt limit, once again? Let me analyze this situation with an analogy.
Living Beyond Your Means
Imagine a young couple who are well educated, married, have a loving relationship, are in their mid-forties, have a couple of kids, both work and have a combined income that puts them in the top 5% of Americans. Let’s assume they make $175,000 in total. So far, so good.
Let’s further assume that they spend everything they make and then some. They have a luxurious lifestyle, which includes upscale restaurants, nice cars, fine clothes and so on. But, their standard of living has caused them to live beyond their means. Each year they’ve added $10,000 to their credit card balance, and after ten years of marriage, they have accumulated $100,000 of credit card debt. Since they have reached the limit on their current cards, they apply for another. If you were the credit card issuer, would you give them a new card with a $20,000 credit line?
You are concerned, so you asked them to meet with you for a personal assessment. The couple impresses you. They are well spoken, smart, educated, well dressed and they talk the talk. So you decide to give them the new card. You give them a sermon about the consequences of living beyond their means, and they completely agree with you. You are reassured.
Fast forward two years. Now they have $120,000 in credit card debt, and they are back to see you and ask for more credit. This time they bring their kids along. They are also well behaved, well groomed, and polite, and they sit and read a book while their parents complete the new credit card application. You remind them that 2 years ago you had scolded them about their spending, and they show remorse and are contrite.
They make some promises that are dear to your ears. In fact, they say they have finally gotten serious about living with less, and they give you some examples of their new found restraint. In other words, they are telling you they finally get it. So, you give in and present them with their new credit card.
Do You Really Believe Their Promises?
Now comes the part where you make a prediction. Tell me, do you really think this couple will modify their spending behavior? What’s your guess? Mine is that they will be back in another year asking for more. That’s because spending is a behavior. Behaviors are very difficult to change. Have you heard of the Yo-Yo diet? People go on diets and are delighted to see the pounds drop, until they return to their original habits and regain more than they initially lost. Living beyond your means is no different.
Will you, at some point, refuse any new credit to this couple? Or, will you keep extending it in the hope that they will reform their behavior?
Replace this couple with the Federal government. It is back asking for more credit . . . and the White House has all sorts of reasons why you should extent it to them . . . the recovery is feeble, unemployment is high, etc. Washington knows how to talk the talk too.
Would You Force Cuts By Withholding New Credit?
At some point, however, somebody has to tell the Federal government to live within their means. Otherwise, things are going to become dire for all of us.
Have we arrived at that point? Would you recommend that Congress take a hard line on credit and say enough is enough and demand cuts?
For the sake of our future, we must live within our means.
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