I’ve not been following the negotiations on raising the debt ceiling very closely. Besides being on vacation and teaching two on line courses, I am simply assuming that they will find a way to raise the debt ceiling. My thinking is similar to why I had little fear of nuclear war during the Cold War — the leaders are not so dumb and irrational as to do something that would guarantee a catastrophe.
Moreover the tidbits I have been hearing — that Boehner and Obama are developing a good working relationship, and that a deal is all but done (and if a big deal falls through the fall back is a small deal) — suggest that they are on course to making a deal and raising the debt ceiling in time to avoid default. But what if I’m wrong?
The worst case scenario is US default and a global unloading of US treasury bonds and currency. The dollar’s value would collapse and the resulting chaos would spiral into a deep global depression, making the last three years seem like a minor pre-catastrophe bump. This could be remembered as an irrational self-inflicted wound that would mark the end of US economic and political dominance in global affairs. But would that really happen? There are a number of scenarios.
The 14th amendment solution: Section four of the 14th amendment reads in part: ” The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned.” One could interpret that to mean that the US cannot default, and the President could unilaterally raise the debt ceiling. The Republicans have had a hostile response to this possibility, noting even that it could be an impeachable offense, threatening to go to court if President Obama tried it. That might avoid economic collapse, but would cause a constitutional crisis with unforeseen political ramifications going into 2012. Even if President Obama were to do that and it were upheld by the Supreme Court, the result would be a loss of power to Congress and even more power in the Executive branch. This isn’t likely to happen, but would be extremely interesting to watch if it did!
Prioritization: The Executive branch could also avoid default by paying interest on current debt and then prioritize the rest of the spending based on what the Treasury department deems most important. If military spending and important programs like social security continue to get funded, there would be little money left to run the rest of the government. This would mean something akin to a government shutdown — though theoretically the Executive branch could prioritize in a way that would punish Republicans. This may be the most likely course of action in the cause of not raising the debt ceiling, with the prioritization both real and political — designed to maximize pressure on the Republicans.
Short term default: Republicans and Democrats could play a game of chicken, each thinking they can wait to the last minute to get the best deal. They may even think a symbolic one or two day “default” will cause minimal damage. That would be a very dangerous game. First, if there isn’t a clear deal in sight by late July, interest rates will start raising on speculation, and once that happens even a timely agreement might not stop an unraveling of the dollar. That’s why most people think the sooner this is passed, the better. Moreover, such thinking could be a path to a longer term crisis, should each side push the envelop and believe they can’t back down without gaining something significant.
Ultimately, the issue comes down to taxes. Most Republican insiders are willing to see tax rates on the wealthiest go up slightly, especially for a short term, and the closing of loopholes also gains support. However, the Republican base sees any tax increase as a defeat, claiming it will harm the economy. (Reality check: spending cuts do more harm to the economy than tax increases since in each case money is taken out of circulation, but government spending is mostly domestic while tax savings go towards consuming foreign made goods or paying down private debt). The Democrats understand spending cuts are necessary, and deep down recognize that entitlement reform is the only way to get long term traction in reducing debt.
A “grand compromise” would see Democrats make concessions on entitlements, perhaps raising the social security retirement age, while Republicans would accept tax increases on the wealthy. Each would risk the ire of their base, but they could claim they did what is best for the US. It appears Boehner and Obama were heading towards such a deal, but the Republican base reacted vehemently against the idea of any tax cuts. Boehner then retreated on the idea of signing off on tax increases, meaning that the Democrats now offer a smaller array of spending cuts, with entitlements fully protected. The bases of each party will be satisfied, both sides hope, even though the deal will be smaller and less profound than either side claimed to want.
The Republicans will risk having it said that Obama just made symbolic cuts and they should have been willing to refuse to raise the debt ceiling to force deeper concessions. Democrats will complain that tax cuts should have been part of the deal, and that Obama was too willing to give in to the Republicans just to get a deal. “He’s not confrontational enough,” they’ll complain. After all, leading Republicans know the danger of not raising the debt ceiling, ultimately they would have likely backed down. Still, such a compromise would be the best way to make sure irrationality doesn’t become policy and we risk economic meltdown.
If the small deal is made, the Democrats might benefit most politically. That will make “taxes on the wealthy” a big 2012 issue, and the Democrats can probably make a reasonable case that this isn’t “class warfare” but asking those who have done very well to pay their share turning around our deficit. Moreover, by not accepting entitlement reform, the Democrats can make that an issue in 2012. That may mean they’ll make promises they can’t keep — I expect entitlement reform will come — but thats a concern for 2014 or beyond.
Right now most of the country isn’t paying attention, and that gives the political junkies a louder voice. Immigration reform had much more support than it appeared in 2007 when the GOP base turned out to kill it. That is the danger — will the leaders refuse to lead, bringing our country into a needless economic crisis at a time we can ill afford more risk? I can’t imagine that a deal won’t be reached, the stakes are too high and the insiders know it. They just need to come up with the appropriate political theater to avoid a backlash from their respective constituencies.