Debt Ceiling Maddness?

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.

  1. #1 by classicliberal2 on July 11, 2011 - 05:24

    I guess I could just cut-and-paste my standard rant about “entitlements.” No entitlement “reform” is being contemplated. People are hanging that label on proposals to enact ruinous cuts in the programs in question, and calling it “reform” is such a mischaracterization as to amount to a lie. Social Security, which is not in any sort of crisis, neither adds a penny to the debt (which is not a crisis, either) nor is it legally capable of doing so, and it has no place in discussions of deficit reduction. The problems presented by Medicare and Medicaid spending have nothing to do with those programs; they are born of the fact that there has been, for decades, runaway inflation in the cost of health care. Nothing that can be done to those programs can fix theses problems–all that can be done is to cut funding that is already inadequate to programs that aid people who are already in dire need of them.

    None of these things are secrets. In fact, every pol in D.C. who is arguing over this knows these things.

    I think Democrats should endeavor to put your own theory to the test, Scott. Let’s see if cooler heads really can prevail. Let’s have no confusion about what a cooler head is, though. Democrats have, by this point, bent over backwards to be accommodating, and it has gotten them nowhere. It’s time they try a change in tactics. They have the public on their side, here, and we’re talking about huge margins. They also hold the majority of the Senate and they hold the presidency, and it’s long past the time they should have started acting like it. Demos should put their collective foot down, tell the Repubs they’re a minority freak show, tell them there will be NO cuts to entitlements, no negotiating any cuts of any kind in exchange for raising the debt ceiling, and dare the Republicans to do anything except either fold like an accordion in the face of this, or stand firm and reap the disastrous consequences. Republicans will not punish their elected officials for standing firm–the rest of the public, on which Republican electoral prospects depend, would crucify them.

    Left Hook!

  2. #2 by renaissanceguy on July 11, 2011 - 07:41

    I resist the notion that a debt celiing should just be periodically raised whenever the debt approaches the last ceiling. That is untenable at some point, and many people believe that we have reached that point (perhaps quite a long time ago). Scott, is there any amount of debt that you think is too much? How about 900 trillion dollars? I’m not sure what comes after a trilion–perhaps quadrillion. Would 500 quadrillion dollars be too much?

    I hope that the U. S. does not default, but wouldn’t it be more likely that we will have to somewhere down the road if we just keep raising the celiing? We do not have an infinite source of money. It’s crazy when we cannot even pay the interest. If we do not bring down the debt, the interest will be beyond our means, too.

    I know that taxes need to be raised, although I am concerned about the morality of overly high taxes. I am also concerned about all the loopholes that will be written into any new tax bill–and you cannot be navie enough to think that there won’t be loopholes. I am concerned that more people will move their assets off shore and that more people will shut down production and otherwise stick it to workers in order to avoid the higher taxes. ]]

    There are so many ways to cut spending without ever touching the big welfare programs. All sorts of grants can be phased out. All sorts of government jobs can be phased out. Whole departments and agencies can be shut down. All sorts of projects can be canceled or phased out.

    I agree with Classical Liberal in one way. Cutting funding is not the same as reform, and nobody in Congress seems to be talking about actually reforming welfare programs, although they could use it. I think that all cuts to programs for the elderly and the retired should be out of the question. People already paid into those things are were promised them. They should be gradually privatized or at least partially privatized, but the government should not go back on its word to those people.

    • #3 by Norbrook on July 11, 2011 - 23:18

      I hope that the U. S. does not default, but wouldn’t it be more likely that we will have to somewhere down the road if we just keep raising the celiing? We do not have an infinite source of money. It’s crazy when we cannot even pay the interest. If we do not bring down the debt, the interest will be beyond our means, too.

      Not necessarily. When we came out of World War 2, we had, as a percentage of debt to the GDP, a far, far, higher percentage than exists currently, or will even with various increases. The other thing to remember is that it wasn’t much more than a decade ago that we were running a surplus, and that the total debt, had that state continued, would have been paid off by now.

      What that comes down to is that it’s not a “eventually we’ll default” situation. However, the insistence on not raising taxes, even when taxes are a historic low, insures that there will be no “balance.” Cuts alone will not suffice. “Living within your means” in this case is the equivalent of saying “I’m going to live on 50% of my take-home pay, no matter what,” and refusing to use a higher percentage when necessary.

    • #4 by Scott Erb on July 11, 2011 - 23:59

      I agree that we can’t keep raising debt levels. To be sure, we are as Norbrook notes, still below our worst debt to GDP ratio, and we’re far better off than Japan, which is at a 200% debt to GDP ratio. Our taxes are historically low now and are low compared to other industrialized states — even if we raise them, I suspect those two facts to remain true. I also agree that there needs to be structural reform in order to create a viable future — not just in terms of the budget, but our entire economy. But in the short term, we need to raise the debt ceiling soon to avoid making the problems even worse.

      I think anything over 60% of GDP is too high a debt to GDP ratio. I believe we’re at 80% now, so that’s above where I’d like to be. I think an optimal debt load is about 30% of GDP. That’s low by historic standards, going back to the early 1800s. I’d like to see us get back to 30% of GDP through a mix of structural reform, and economic growth. It won’t happen overnight.

  3. #5 by modestypress on July 12, 2011 - 01:26

    Life is not fair. I remember a kindergarten teacher or someone from about that time which would be about 50 years or so telling me that).

    However, the “lesson” has taken. Everyone has now observed that life is not fair. In general, people have fallen into two camps.

    1) Life is not fair. Let’s make it fair: helping people who are sick, poor, out of work, oppressed, discriminated against, et., etc. As soon as we start down this path two things happen: a) We go broke. b) We never succeed in making EVERYTHING fair so we end up fighting and squabbling about what is fair and in the process go even broker. (Even lawyers are now going broke.)

    2) Life is not fair, so the fair thing to do is to help ourselves. We can help ourselves by working hard, or by being born to rich parents, or by being born in a rich country (Saudi Arabia, etc.), or by being very talented, or by being very successful criminals, or by being very lucky. Humans like to think of themselves as “rational” beings, but mostly we are rationalizing beings, se people in camp #2 rationalize their success and/or good fortune as “only fair” (because I am white or because I am back or because I can hit a baseball or because I don’t mind shooting people to get what I want, or whatever.

    Let’s do a ridiculous thought experiment. Imagine everyone in our country divided up into one or the other of these two camps. They would argue incessantly, head towards “class war,” and so on.

    It would be a recipe for disaster. Fortunately, that is just a ridiculous idea I had, and it would never happen in real life. For example, just read the comments about this blog post before mine. Consider how sensible, open-minded, and “rational” they are.

  4. #6 by Scott Erb on July 12, 2011 - 14:36

    A friend of mine posted this on facebook: “In 2001, revenues were at 19.5 percent of gross domestic product and spending was at 18.6 percent of GDP. That was our surplus. In 2010, revenues were at 14.9 percent of GDP while spending was at 23.9 percent. That’s our deficit: Revenues are down and spending is up.” Source:

  5. #7 by brucetheeconomist on July 13, 2011 - 14:54

    I think the President if he had been less political, should have backed away from Bush tax cuts across the board by same the middle of 2012. That is given that those tax cuts were justified based on the brief surplus of the late 1990’s, I can’t see why we maintain them for anyone.

    Recent history clearly shows the tax rates of the late 1990’s have little ill effect on the economy.

    Even with the Bush tax cuts gone, I think we’d need to make some entitlement cuts as we well, but the size of the whole would be dramatically smaller. Ultimately, we should shoot for a surplus during normal economic times

    Can the debt ceiling rise indefinitely? I’d say yes as long as we mange to keep the size of our debt and debt service about the same share of the overall economy. Most large corporations always carry debt as well equit obligations, and those debt obligations rise as the firm grows. Government debt is more or less then same, though government for accounting purposes doesn’t capitalize very many things.

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