But isn’t there a better way to increase a borrowing limit — and one that doesn’t freak out markets, investors, and, well, just about everyone every few months?
Why the United States Cannot Default
In this post, I am not going to argue that the USA should not default because it will cause havoc in global financial markets. This — if the debt limit is not raised or abolished via a trillion dollar coin or other means by October the 17th — is a distinct possibility, but much has been said of this already. Nor am I going to argue that the United States Treasury will somehow manage to skirt defaulting via emergency austerity measures. This is possible too, though has also been discussed elsewhere.
I am going to argue that in the long run, whether the United States raises the debt ceiling or not, it is technically impossible for the United States to default. This simple fact is encoded in the Fourteenth Amendment to the Constitution:
Section 4. 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.
While bondholders may not get their money including interest immediately, the courts will rule in their favour when the matter comes to court. The Fourteenth Amendment is absolutely clear on that. Some credit default swaps may trigger (this depends, I think, on the wording of individual credit default swap contracts, which in itself may cause further confusion) but in the end bondholders will absolutely and assuredly get their money. This means that United States Treasuries remain low-risk assets. And that — even in the event of default — should keep interest rates on Treasury debt relatively low. There will be no crushing exit of the bond vigilantes — after all, why would they choose to crash a market they are already deeply invested in if they will sooner-or-later get paid? People, generally, who buy large quantities of US Treasuries are not sitting around and reading libertarian blogs pondering the issues of dollar debasement and the end of the dollar as the global reserve currency. The latter may be a real longer term issue, and I think in the next 50 years, perhaps even the next 20 years we will see more alternative reserve currencies emerge. But that is another story for another day.
In the medium term and the short term the thing that is keeping bond buyers buying bonds is the search for yield over cash. If you have billions of dollars in cash at your disposal as many investment managers and countries do, and your imperative is low-risk yield, government debt beats cash that yields nothing, it beats commodities speculation and stock market speculation, and it beats corporate bonds as corporations are not sovereigns. A guaranteed dollar-denominated yield, even a very low one is still very attractive to treasury buyers, even if some large treasury buyers like the Chinese government have made some bond-vigilante-like noises in the past few years. These have thus far proven to be hot air, even if I have in the past made the mistake of paying too much attention to such noises.
Personally, I wish to see the debt ceiling abolished entirely, either through the absurdity of trillion dollar coins (my original objection, that authorising a trillion dollar coin would look silly has been made entirely moot by the fact that the United States Congress already looks extremely silly due to the ongoing standoff) or otherwise. At the very least, the debt ceiling should be denominated in real economic activity, not an arbitrary number of dollars, and in setting such a ceiling it should be remembered that Great Britain successfully sustained and paid down a sovereign debt of over 250%. Higher sovereign debt levels for a rich, powerful country like the United States are not dangerous. It is — as we are seeing — destructive both to markets and to society that a sovereign can be reduced to gridlock and turmoil and confusion over such a simple thing as a spending or borrowing authorisation. The real dangers here are not overspending or running out money, but unnecessary forcible austerity imposed by lawmakers, sucking money and economic activity out of the economy, and creating chaos and confusion in markets. There are already many real problems in the US economy — millions of people unemployed, weak growth, lack of job creation, private debt overhang and slow, painful deleveraging. The last thing the US economy needs is an unnecessary crisis of uncertainty and confusion created by economic illiterates in Congress.
On The Debt Ceiling & Drowning the Government in the Bathtub
The mainstream coverage of the debt ceiling standoff and the prospect of government shutdown and how that thing is seen by the people who might precipitate it is predicated upon a fundamental misunderstanding. To the Tea Partiers and Grover Norquist-Ted Cruz-Rand Paul wing of the Republican Party, a government shutdown is seen less as a potential disaster in which markets and society are sent into turmoil, and more as a potential wonderland of enforced austerity where with the government handcuffed, the creative forces of the free market are finally unleashed.
The libertarian financial analyst Mish Shedlock exemplifies these sentiments:
Looking for a reason to support a government shutdown? If so, please consider Obama Stripped to Skeleton Staff in a Government Shutdown.
Mish points to the austerity measures the government would be put under:
A U.S. government shutdown means President Barack Obama will have fewer people to cook meals, do the laundry, clean the floors or change the light bulbs, according to a White House contingency plan.
About three-fourths of president’s 1,701-person staff would be sent home. The national security team would be cut back, fewer economists would be tracking the economy and there wouldn’t be as many budget officials to track spending.
Of the total, 438 people work directly for the president. Under a shutdown, 129 could continue working, according to the contingency plan.
Biden, who has a staff of 24, would have had to make do with 12.
Obama’s national security staff of 66 would be cut to 42. Similar staff cuts would be imposed at the White House Office of Management and Budget, the Council on Environmental Quality, the Council of Economic Advisers and the Office of National Drug Control Policy, which are all part of the president’s executive office.
If you think that a government shutdown is a fantastic idea (I sure do), then please contact your elected representatives and let them know.
But there are at least two other factors beyond simply wanting less government that may make a government shutdown and debt default attractive to the Tea Party wing.
The first of which is that the austerian worldview exemplified by the Wall Street Journal editorial page — in which large-scale deficit spending was expected to precipitate soaring interest rates and inflation — has largely been proven wrong by events. Interest rates and inflation have remained low. The Tea Party wing of the Republican Party now has an opportunity to try to make their initially wrong predictions come true by throwing the United States into default on its debt, and sending a message to markets and international investors that the US government and US Treasury debt is not a safe asset. Whether or not a government shutdown would actually result in a debt default (the Treasury would under such an eventuality likely prioritise debt service), and whether this would actually lift interest rates significantly are other matters, but shutting down the government and defaulting on the debt would certainly enforce austerity which is what the Republicans and especially the Tea Party wing want.
The second — and perhaps the greater factor — is the desire to prevent Obamacare taking effect. Now, I am not convinced that Obamacare can bring down healthcare costs as much as a Canadian-style or European-style system. Obamacare is certainly not an ideal system, although its earlier implementation in Massachusetts does appear to be fairly successful . But it does bring the United States much closer to something approaching universal coverage. With the message of the last Republican election campaign being that 47% of the population (the “takers”) is mooching off 53% of the population (the “makers”), Obamacare is seen by the Tea Party wing and probably the Republicans in general as the last turning point on the road to socialism. And avoiding the implementation of Obamacare is something that, I think, the Republican Party and especially the Tea Party wing will go all out to do.
Now, how far the Republicans are willing to go down this road remains to be seen. The more moderate wing may be willing to settle for a deal that avoids government shutdown in return for increasing the pace of austerity. But the impending implementation of Obamacare, and the general attraction of a government shutdown will strengthen the will of the Tea Party wing to not negotiate.
Personally, while I do think we are in the long run headed toward a world of increased decentralisation and a lesser state role (primarily as the result of technology), I don’t think a government shutdown will do anything to advance the cause of human liberty. In fact, I think a longer-term shutdown would probably end in civil unrest — a lot of people are dependent on government spending for income — and market turmoil (not least because markets seem to have priced in an easy resolution to the standoff). So the standoff will almost certainly end in a deal permitting a debt ceiling increase. How much carnage will occur before then remains to be seen.
Why the Debt Ceiling is a Dead Issue.
The Elephant in the Room?
I spent the last three days writing blog posts on economics without ever mentioning the “hot button” issue of the day: the United States Treasury running out of juice, and having to yet again raise its debt limit. For those with a short memory, or a lack of interest, here’s a figure of the U.S. debt, first in absolute terms: