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Economic Forecasts

Lawmakers, Obama Will Reach Debt Ceiling Agreement

Both parties in Congress will give ground to avoid default, but it's not going to be pretty.

When push comes to shove, Congress will boost the U.S. debt ceiling. There’s no sensible alternative.

Until that moment is reached, though, the bitter partisan fighting in Washington will continue to escalate, with Republicans resisting tax hikes and Democrats saying cuts alone won’t work.

The technical deadline is August 2. After that, Treasury Secretary Timothy Geithner and other administration officials say, the United States won’t be able to pay its bills and will default on its debt obligations, unless lawmakers agree to raise the debt limit beyond the current $14.3 trillion cap.

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The real deadline, probably earlier, is whenever the financial markets start getting the jitters about the prospect of the United States defaulting for the first time ever. That’s when a deal will get done, whether it’s as early as mid-July or two weeks later.

Yes, the level of debt piled up by the federal government is unsustainable. And yes, something must be done about it. But a problem that took years and years to develop can’t be solved immediately. And it most certainly can’t be solved by pulling the plug on U.S. spending, which is essentially what some Republicans are suggesting when they propose not raising the debt limit and forcing the government to cut its way out of the deep financial hole.

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Rep. Michele Bachmann of Minnesota, a top GOP presidential contender, says missing the Aug. 2 deadline won’t result in an immediate default because the U.S. can still make interest payments by holding off on paying other bills. That view, if she maintains it, will doom her chances of becoming the next president.

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The problem is the markets won’t wait to see if she’s correct, and will be in meltdown mode on deadline day, if not before. Every investor, here and abroad, will have to weigh the perceived safety of an investment in U.S. Treasuries against the chances that political posturing will result in defaults down the road, even if one is avoided at the last minute this time. They would either not invest or insist on a higher interest rate as a risk premium.

For now, talks between President Obama and Republican congressional leaders are deadlocked, with each side waiting for the other to blink. The GOP is willing to raise the limit by more than $2 trillion, but only if a similar amount is trimmed from the deficit over the next decade. Republicans are nearly unanimous in their opposition to higher taxes. Indeed, many of them have signed pledges to not raise them under any circumstances.

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In the end, though, political reality suggests Republicans have to give up something as the debt debate reaches critical mass in the coming weeks. They control the House, but Democrats hold a majority in the Senate and there’s a Democrat in the White House. You can only say “my way or the highway” if you own the town, and right now Republicans don’t. They have to give ground on something they cherish, especially since Democrats will have to allow deep cuts to some of their favorite programs and will, at some point, be forced to agree to some changes in entitlement programs such as Social Security, Medicare and Medicaid.

So while the talk of digging in and letting the country default will score points with Tea Party GOPers, most Republicans in Congress know that undercutting the economy and imperiling the fragile recovery from the Great Recession is a path to defeat in the 2012 elections. Enough of them will agree to what they see as bitter medicine — some higher fees, perhaps, or reducing or eliminating some tax write-offs — to go along with spending cuts. If not now, then next year, after agreeing to raise the debt ceiling by a smaller amount before the August 2 deadline.

It won’t be pretty, and there will be political casualties in the next election. But there is no other option. The United States is too big to be allowed to fail.

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