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Debt Showdown: Road To Another Financial Disaster?

Aug. 2: the day of debt reckoning. According to President Obama, the U.S. will default on its obligations that day if Congress does not raise the debt ceiling. With this debt-ocalypse just under a month away, one begins to think about what would happen if Americans wake up that morning to find Congress still deadlocked.

Annie Lowrey, business reporter for Slate, imagines a worst-case scenario.

"First what's going to happen is that the value of Treasury bonds is going to go down," Lowrey tells weekend on All Things Considered host Guy Raz. "People are going to start hoarding cash. After that, businesses are going to have a lot of trouble with their short-term funding."


Financial markets around the world will freeze up, leading to another financial crisis. The U.S. could plunge into recession again.

Lowrey paints a bleak picture, but Peter Morici, a professor at the University of Maryland's Robert H. Smith School of Business, says the government has a few more tricks up its sleeve to stave off such an outcome.

First of all, Morici notes that the government has enough tax revenues to pay interest on the national debt, as well as cover Medicare, Social Security, and most defense spending. But the rest of the government would have to shut down.

To avoid that outcome, the Treasury Department could print money to pay government obligations. The Federal Reserve would then sell off some of its $1.6 trillion worth of Treasury bonds to keep the money supply in order.

But how much time can this plan buy?


"We could keep the government going another year at its present levels," Morici says.

Which kicks the problem right to the heart of the 2012 campaign season.

Congress At Loggerheads

Sen. Sherrod Brown (D-OH) is worried about the consequences of not raising the debt ceiling by Aug. 2. Like Lowrey, he foresees a severe financial crisis. Brown tells Raz that such a crisis "will certainly hurt our standing in the world, the strength of the dollar, and the reliability of the United States of America as the premiere economic power in the world."

But when it comes to congressional negotiations to raise the debt ceiling and avert disaster, Brown says that cuts in Medicare are a deal-breaker for him and many of his Democratic colleagues. He sees other alternatives to closing the budget gap.

"Defense needs to be on the table, and ending some of these outrageous tax breaks for Wall Street and Big Oil," he says.

Despite the intense disagreements with Republicans about the best ways to close the budget deficit, Brown is optimistic that a debt-ceiling increase will pass before Aug. 2.

"I have enough confidence in (House Speaker) John Boehner, that he will have the skills and will be grown up enough to convince enough Republicans to join with Democrats and do the right thing," Brown says.

Rep. Jeff Flake (R-AZ) isn't so sure about that.

When asked by host Raz if he thinks the government would default on Aug. 2, Flake answered, "Yes. I think that's a distinct possibility unless we come to some agreement."

For Flake, that agreement would entail steep spending cuts now, spending caps for the near future and a balanced-budget amendment to ensure fiscal health further down the road.

Flake opposes an increase in tax rates, but unlike many of his Republican colleagues is open to the defense cuts that Democrats like Brown advocate. This bit of common ground may be a start to a compromise, but Flake doesn't think Congress will raise the ceiling any time soon.

"Congress tends to act right when we hit the fiscal cliff," he says.

Where's The Cliff?

If the U.S. does fall off the edge of its fiscal cliff, the tumble would resemble something like Lowery's prediction. One would think that as the government steps closer to its default date, financial markets would begin to panic.

Yet the stock market just had its best week in two years.

This behavior puzzles even Nobel Prize-winning economists like Paul Krugman, a columnist for The New York Times. He says that this week, traders were buying short-term U.S. government debt at very low interest rates. These traders seem certain that a deal will be worked out.

"It's very hard for market participants to wrap their heads around the fact that the United States is so close to becoming a dysfunctional banana republic," Krugman says. "I hope they're right, but I don't have confidence in it."