The Debt Ceiling And The Politics of Crazy

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    Creigh Gordon
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    What’s up with the debt ceiling increase?

    Edward D. Kleinbard, a former chief of staff for the Congressional Joint Committee on Taxation, has an editorial in the New York Times today, basically predicting disaster if the debt ceiling is not increased:

    “Sometime in October, the United States is likely to default on its obligation to pay its bills as they come due, having failed to raise the federal debt ceiling. This will cost the Treasury tens of billions of dollars every year for decades to come in higher interest charges and probably trigger a severe recession. The debt ceiling is politically imposed, and the decision not to raise it, and therefore to choose to default, is also political. It’s something America has avoided in the past. This time, though, will be different…
    …An increase in Treasury interest rates of just 0.2 percent a year would cost the government about $400 billion over the next 10 years. It also would lead to higher borrowing costs for American businesses, because borrowing rates are set by reference to Treasury rates. Moreover, each month holders of tens of billions of dollars in valid claims against the United States would go unpaid, triggering a major recession. None of this is particularly speculative; almost all economists and policy makers agree on the enormous fiscal, economic and reputational costs of default. That’s why, in the past, we’ve always managed to avoid it.”

    Before considering strategy options, let’s consider the debt ceiling itself, which is entirely a self-inflicted phenomenon. It exists for three reasons, none of which are compelling.

    The first is historical: under a gold standard, one way to protect your gold supply was to swap convertible dollars for nonconvertible (until maturity) bonds. This is no longer relevant, since dollars are not convertible.

    The second is legal: Congressional law regulating the Federal Reserve Bank prohibits the Bank from lending money directly the Treasury. The Fed does, however, buy Treasury bonds from the private sector, who buys them from the Treasury. The result is exactly the same as if the Fed credited the Treasury directly, and if Congress simply rescinded its prohibition, the Fed could and probably would do exactly that.

    The third reason is operational: Treasury bonds enable the Fed to manipulate the interbank overnight interest rate on reserves. The Fed accomplishes this manipulation by swapping Treasury securities and reserves held by the private sector, which enables the Fed to control the supply of reserves outstanding. Lets just say at this point that there’s no compelling reason to believe that the interest rate manipulations do anything useful that couldn’t be done in other ways.

    Bottom line, there’s no reason for the Government to “borrow” (sell bonds) in the first place. It could just print money instead.Failing that, it could just eliminate the debt ceiling But those things won’t happen, so we need a debt ceiling strategy.

    What has usually happened with the debt ceiling increase is that the majority party votes for it, while the minority party votes against it, and then bashes the majority for the vote.

    After being ambivalent for some time, the White House has now come out in favor of a clean increase. There doesn’t seem any way Republicans in the House will come up with enough votes to pass any increase. Some members won’t vote for any debt increase, and some will only vote for a bill that cuts spending along with the debt increase. No Democrats want to vote for a debt increase, and a bill that cuts spending will fail in the Senate because it will be filibustered and therefore require 60 votes.

    The President is being put into an impossible situation. He is required by law to spend appropriated funds, but the Treasury doesn’t have and is legally prevented from creating the money needed to fund the appropriated spending. The President’s primary Constitutional duty is to “see that the laws are faithfully executed,” but the Constitution doesn’t say what he should do when there are conflicting laws.

    If, as seems quite possible, the debt ceiling is not raised, the only choice will be to prioritize spending, or evenly spread the haircuts across all Government activities. I don’t think that the economic effects will be as dire as Mr. Kleinbard thinks, at least not right away, but the political effects of reducing or delaying Social Security checks, Medicare payments, military expenditures, and/or bond payments will be immediately unsupportable.

    So what should Democrats do? Vote for a clean increase and save the Republicans from their own obstinacy, and endure the political heat? Impose conditions of their own in return for the votes? Because I don’t think the short-term economic effects will be as bad as some expect, I think Democrats should do nothing, at least not right away. Don’t vote yes, don’t vote no. Put it on the Republicans. Doing anything else plays into the crazy people’s hands. Call their bluff and end this stupid game.

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