US hurt by debt ceiling theater – 05/16/2023 – Martin Wolf

How to assess the possibility of a voluntary default by the most important country in the world? Is it really likely that something so insane will happen? What would be the consequences if that happened?

These questions are impossible to answer. This is not due to the fact that the event is a “black swan”, that is, unimaginable. Instead, the US default falls into a broad category of “known unknowns,” that is, high-impact, high-impact events that are impossible to predict. The 2007-09 financial crisis, the pandemic, and Russia’s invasion of Ukraine were such events.

It is impossible to predict events like this due to their rarity and the complexity of their causes. We don’t know enough to predict when and in what form the next pandemic will strike, when and where someone will start a war, or whether US politicians will destroy the credit accumulated by their country for centuries. However, we know that these shocks happen. They are part of our reality.

So what about this specific threat? It is not normal for a country to have a legislated budget and a separate authorization procedure for the debt that this budget entails. For the United States, this was a product of wartime necessity: prior to 1917, Congress had to authorize every individual loan. And to this day, the US debt limit has always been raised when necessary. This apparently happened about 90 times.

Reasonable people would conclude that the ceiling is nonsense. But he is not irrelevant. Increasingly, Republicans are looking to the debt limit as a lever that allows them to limit spending — but not, it should be noted, the deficits caused by tax cuts. They happily accepted deficits during the administrations of George W. Bush and Donald Trump.

Therefore, as a Brookings Institution explanatory text notes: “Over the past three decades, the cap has precipitated policy battles during which some lawmakers have used the debt ceiling vote to try to slow the growth of federal spending.” This happened to Barack Obama in 2011 and to Joe Biden in 2021, before the debt ceiling was raised to $31.4 trillion, where it is now. The need to raise it once more has become very urgent as the federal government may run out of money in June.

Can a default occur? The answer is yes”. One of the reasons is that the parties are too far apart. The Republicans’ proposals would impose a 47% cut in total non-army-related real discretionary spending between 2024 and 2033. That’s a huge gap to fill, even if background music may be improving. The other reason is that key players may feel they have no incentive to compromise. Republicans are very divisive, some hold extremely radical views, and many seem to think that even an economic disaster would only hurt the government. Meanwhile, Democrats may find compromise on spending too painful. In Russian roulette games like this, disasters do happen.

There are those who hope that the situation can still be managed, at least for a while. The 2011 plan would have involved maintaining interest and principal payments but deferring payments to agencies, contractors, Social Security beneficiaries and Medicare providers. More radical proposals involve a $1 trillion platinum coin or recourse to the 14th Amendment to the US Constitution, which states: “The validity of the public debt of the United States, authorized by law … shall not be questioned.” With the current Supreme Court, it is doubtful that this will work.

Think of all the people, institutions and countries that hold US Treasuries as the safest and most liquid assets in the world. Even a small interruption in payments could be devastating for confidence, not just in Treasuries but in equity markets. The possibility of default can be dismissed as unrealistic. The experience of a default would certainly be very real.

Furthermore, default would be a major shock to confidence in the United States. Michael Strain of the American Enterprise Institute, a conservative research institution, argues that “The world’s foreign leaders and investors would look at the United States and see a damning picture. In this broken system, many elected officials do not respect the results of a presidential election. and allow political and ideological differences to get in the way of meeting the government’s financial obligations. Investors would think better about allocating capital to US entities, and the US role as a beacon of liberal values ​​- including free markets – would be seriously harmed”. To sum it up more simply: they would conclude that lunatics had taken over the asylum.

Even if the worst is avoided this time, the repetition of this game of Russian roulette makes it cumulatively more likely that an actual crash will occur. Glenn Hubbard, former chairman of the White House Council of Economic Advisers in the Bush administration, made reasonable suggestions. What is needed, in fact, is a long-term solution in which the theatricality of the debt ceiling is replaced by a coherent long-term budget. The current trajectory of US debt makes proposals like these necessary.

However, set against this is the fact that efforts by Democratic presidents such as Bill Clinton and Obama to reduce prospective deficits only served to allow Republicans to lower taxes when they returned to power. And, in this way, will there be political will to put the needs of the country above party needs? Nor can we define the situation as a double failure. The blame rests heavily with the Republicans. They use the threat of a default to achieve spending and tax cuts, but not the deficit, and so have been unable to secure decisive electoral victories.

Ultimately, “it’s all politics, stupid”. The only reason a default is conceivable is the depth of disagreement in the country and therefore in Congress. If America were less divided, the debt ceiling would not matter. But in today’s divided America, he matters. As long as divisions continue, so will the threat of a default. Even if a temporary agreement is reached, the threat is likely to return soon.

Translated by Paulo Migliacci

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