Going for broke could break fragile economy

The Treasury is expected to have enough cash on hand to pay a $23 billion round of Social Security benefits Wednesday, but, without an increase in borrowing authority, it will have to conserve funds to be sure it can make a critical debt payment Aug. 15. That means it may have to selectively defer paying other government bills, including employee salaries, contracts, military and veterans’ pay and benefits, and state and local grant payments.

Economists estimate that the Treasury will have run out of cash by midmonth and will be in danger of defaulting on the debt and otherwise not being able to pay about 40 percent of obligations that come due.

Barclays Capital economists estimate that the biggest blow to the economy would come from such a sudden drop in federal spending, which would affect senior citizens, troops and other consumers who depend on government benefits for their income, as well as contractors and state and local governments that depend on federal payments to make payroll and pay other bills.

The ratings agencies have warned that numerous states and cities could be downgraded if the Treasury starts selectively delaying payments because they depend in part on federal transfers to make payments. Many businesses also could suddenly be unable to pay their own bills and debts if they don’t receive expected payments from the government.

David Greenlaw, an economist at Morgan Stanley, said he is not worried so much about immediate spending cuts because he thinks Congress will enact borrowing authority in time to prevent a lapse in federal payments. He also said the spending-cut plans being discussed by party leaders likely will not do much to deter the economy this year, as the cuts are mostly “back-loaded” into future years.

What does worry him is the looming expiration of payroll-tax cuts and other programs that were enacted at the end of last year to stimulate the economy. They have become “lost in the shuffle” in the debt debate, and they may not be revived, he said. The White House sought an extension of the stimulus measures as part of a “grand bargain” on the debt that never materialized.

That means the economy is headed for a sharp contraction in federal support at the beginning of next year, Mr. Greenlaw said. He said he is also “concerned about the general uncertainty and impact on business and consumer behavior” from the prolonged fight in Congress. Some businesses have put off hiring and investment while they wait to see what happens.

“That’s becoming an increasingly important issue,” he said. “If this drags on for long, you will see more of a headwind for the economy.”

“Even if the debt standoff is resolved quickly this week,” said Nigel Gault, an economist at IHS Global Insight, “the extreme uncertainty will surely already have damaged third-quarter growth by hurting consumer and business willingness to hire and spend.”

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