July 7, 2011
Flirting with Catastrophe

It’s hard to write when you’re speechless. The fact that Congress is even debating whether to raise the debt ceiling means our politics is broken. The fact that that the debt ceiling may not be raised… Well, I’m speechless.

What would happen if the debt ceiling isn’t raised? For one thing, according to a report (that only covers the month of August) by the Bipartisan Policy Center, it means federal spending would have to immediately contract by 44 percent. 44 percent. This would make Greek austerity seem feathery. Jay Powell, an undersecretary of the Treasury under George H.W. Bush and the report’s lead author, notes that a 44 percent cut in federal spending is a 10 percent cut in GDP. For comparison, in the final quarter of 2008 and first quarter of 2009 the economy contracted at an annualized rate of 6 percent, a downturn that brought us the Great Recession and lingering unemployment now at 9.1 percent. It’s hard to throw out numbers, since the nature of the situation is so unclear. But obviously there’d be a dramatic uptick in that statistic.

But it would be worse. If the debt ceiling isn’t raised, the Treasury will have to choose what to spend money on. The BPC paper lays out two scenarios, a “Protect Selected Big Programs” scenario and a “Protect Safety Net” scenario. In the former, the Treasury pays interest on the federal debt, Medicare and Medicaid, Social Security, defense contractors and unemployment insurance.,but stops paying military salaries and IRS refunds, defunds the Veterans Affairs Administration, the Centers for Disease Control, food stamps, education, and NASA, shuts down air control, freezes paychecks of all federal employees, and much else. In the latter scenario, the Treasury pays interest on the federal debt, Medicare and Medicaid, Social Security, food nutrition services/TANF, HUD, Veterans Affairs programs, and unemployment insurance, but stops paying defense contractors, military salaries, IRS refunds, federal salaries, and defunds NASA, the Department of Energy, Health and Human Services, the Interior Department, and much else.

However one slices it, the Treasury would take on dictatorial powers to determine which programs are funded and which policies are implemented. (No doubt Republicans espy the inevitably controversial decisions the Treasury will have to make as a chance for vitriolic critique and partisan gain.)

But it would be worse. Paying interest on the debt, as in the above scenarios, may seem to spare the bond market. But the Treasury must also “roll over” (attract new buyers into) almost $500 billion of debt that matures in August. That would almost certainly require higher interest rates. In addition, the ratings agencies may downgrade U.S. government debt, which would push rates still higher. Since interest rates in general (mortgage rates, credit card rates, auto loan rates, corporate borrowing rates) are linked to Treasury rates, interest rates in general will rise. (And did I mention that higher interest rates slow the economy?) And higher rates would force financial institutions to mark down the value of key assets (“riskless” Treasury bonds), probably pushing many into insolvency.

And there’s more. Recognizing that they may soon stop receiving government checks, government contractors, seniors, and others are likely to start hoarding cash, worsening the liquidity trap we’re already in.

And we haven’t even gotten to the possibility of default, which could throw the international financial system, which is built on the perception that U.S. government debt is perfectly safe, into chaos.

It really does take a stomach to peer into this abyss, and the Bipartisan Policy Center has done yeoman’s work. And remember, they looked only at August.

In sum, failure to raise the debt ceiling would be cataclysmic. Our two-year-old recovery, tepid though it’s been, would be a thing of the beloved past.

There’s no issue about who’s most culpable for the impasse. Obama’s starting bid in the Biden talks was $2 trillion in spending cuts for $400 billion in taxes, an 83:17 split. (And don’t forget that tax revenues and rates are at historic lows.) That’s more than bending over backwards to avoid a crisis. Eric Cantor and other Republicans walked out of those talks over the administration’s proposal to end tax breaks for oil companies and corporate jet owners.

Of course, it’s silly that there is a debt limit. Congress appropriates every penny of federal government spending and thus incurs every penny of federal government debt. Now it needs to vote on whether to pay that debt?

Why are the Republicans doing this? Why, when Republicans voted overwhelmingly to raise the debt ceiling seven times during the George W. Bush administration, are they balking now, pretending to care about a long-term debt problem they largely created? Why, two years into a tepid recovery, are we suddenly debating whether to tank the economy and take the world economy down with us? It seems too farcical to be true. And for many it is. Many observers simply can’t believe the Republicans would act so irresponsibly—that surely they’re just playing the “crazy” card for all its worth but will yank it back before push comes to shove. Besides, wouldn’t their Wall Street benefactors (our strange bedfellows) sit them down and explain that they will raise the debt ceiling?

But they’re playing a dangerous game. Think nuclear deterrence, Dr. Strangelove’s doomsday machine, Nixon’s “crazyman” theory of the presidency. The point is to keep your opponent from knowing whether you’re really crazy, or, perhaps better, to visibly tie your hands in a way that will force you to act insanely. The other side (the reasonable side) will have to back down. The Republican leadership perhaps isn’t crazy (though it’s hard to tell), but they’re tied to a Tea Party base that is.

My cynical best guess is that the Republican leadership wants to rattle the bond market just enough to raise interest rates, stall the recovery, and pin a continuously weak economy on Obama. This won’t help their Wall Street benefactors, but you win some, you lose some. The Republicans will still do all they can to neuter Dodd-Frank.

*As I write, a report has come out that Obama is offering cuts in Social Security and Medicare in exchange for revenue increases (rescission of Bush’s high-end tax cuts?). I’m guessing (hoping) this is just a way of exposing the Republicans’ intransigence and signaling to his opponents that he’s also tied to a base (a base that won’t tolerate cuts in these programs, as Obama surely knows).