Peter Schiff

Both Congress and the President readily admit that without an increase in the debt ceiling, the government will default on its obligations. This is tantamount to an admission that we lack the capacity or political will to actually repay what we have borrowed. Yet despite this, our creditors continue to loan us more money. As existing treasury bonds mature, we not only borrow the money necessary to redeem them, but we borrow it from the very people cashing them in. So it's not really like paying our Visa bill with our MasterCard, it's like paying our Visa with our Visa.   

The debt ceiling itself is both an ill-conceived compromise and a relic of past governmental integrity. For its first 128 years as a republic, the United States was able to function without a debt ceiling. This was possible for the simple reason that U.S. government had no central bank and could not borrow beyond its ability to repay through taxation. And since the ability to tax is always limited by taxpayers' assets (and their extreme hostility to those who want to take them), legal gimmicks were not needed to prevent Congress from spending too freely. But the creation of the Federal Reserve in 1913 gave the Federal Government a potential means to borrow indefinitely by having the new bank buy its debt. Sensing this danger, the original Federal Reserve Act of 1913 prohibited the Fed from buying or holding government debt.

But just four years later the United States needed a means to raise money quickly to pay for its efforts in the First World War. The government passed an amendment to the charter to allow the Fed to purchase Treasury Bonds. Fearing (correctly) that this would create a mechanism for perpetual debt expansion, conservative lawmakers insisted that the amendment include a "debt ceiling" provision that would cap the amount that the government could borrow.

What these otherwise forward looking politicians somehow failed to grasp was that such a statutory limit was wholly meaningless, as it could be perpetually raised by future legislative action. This is exactly what has happened. The debt ceiling has been raised, with varying degrees of fanfare, every time it has been hit. This renders the law completely meaningless.     

Now of course, under the pretense of fiscal responsibility, the President wants to do the most fiscally irresponsible thing imaginable -- eliminate the ceiling entirely. He hopes that doing so will send a clear and unequivocal message that America will never default on its debts. However, the message may not resonate the way the President hopes. What our creditors may actually hear is that nothing will stand in the way of America's accumulation of more debt. Such a development may be the shock therapy our creditors need to finally cut us off for good. If that occurs, interest rates in the United States could finally rise to more rational levels. A significant increase in the cost of borrowing will create the mother of all fiscal cliffs. It's too bad that Tim Geithner can't see that one coming.

Peter Schiff

An expert on money, economic theory, and international investing, Peter is a highly recommended broker by many leading financial newsletters and investment advisory services. He is also a contributing commentator for Newsweek International and served as an economic advisor to the 2008 Ron Paul presidential campaign.
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