The Politics of the Debt Ceiling

My US debt ceiling series continues. We’re still at $14 trillion or so. This time, I want to look more at the politics of the situation and how I expect it to actually play out.

I’ve previously discussed how we should switch to a debt/GDP ratio instead of an absolute level of debt set as some arbitrary increase on top of the current level. I’ve also previously discussed how government finance really isn’t much different than personal or business finance, save the government being able to print money and inflate their way out of debt.

It’s not the first time, and sadly, it won’t be the last time. In fact, it’s more like that time every couple years where you’re home sick from school/work, completely bed-ridden and miserable, and the TV is stuck on the rerun of a really bad movie. But, I digress.

First, what if we hit the ceiling? Two things happen. One, the global markets get nervous, which can lead to all kinds of unintended consequences. In theory, we could end up being the fodder for global headlines of impending fiscal doom, sort of like Greece, Spain, Portugal, and Ireland have been recently. Our borrowing rates, as measured by Treasury note rates (yields), could increase like theirs did. With bonds, yield moves in the opposite direction of price, so as bonds get sold, the price drops and yield rises, but as bonds get bought, price rises and yields drop. The Treasury rates are what the government pays to borrow money. Also, many private loans, like mortgages, cars, and business loans, are indexed to Treasury rates, meaning they rise and fall with Treasury rates. So, if the market gets nervous about the US, our Treasury bonds will get sold because investors are scared to hold them, and rates will rally. Increasing borrowing rates increases the costs of borrowing. If you can only afford a certain mortgage payment per month, with all else equal, you can buy a more expensive house if rates are at 5% versus 6% because less of your monthly payment goes to paying interest costs.

Two, the government can’t borrow any more money, so it must get creative to keep things going. Such creativity includes finding money, like Clinton Treasury Secretary Robert Rubin did when he borrowed about $60 billion from federal pension funds. It also includes deferring costs, as Reagan Treasury Secretary James Baker did when he delayed payments to the Civil Service and Social Security Trust Funds. We’ve already done some of these, too. The bottom line is there’s no shortage of band-aid fixes that can be done to handle the problem in the short-term, but the only long-term solution is to reduce spending and juice GDP to reduce the debt/GDP ratio I’ve been harping on.

It’s interesting to see how, in the world of politics, your views change depending on what side of an issue you’re presently on. A Democrat senator spoke about it during George W. Bush’s 2006 request to raise the debt ceiling to $9T. “The fact that we are here today to debate raising America’s debt limit is a sign of leadership failure. It is a sign that the US government can’t pay its own bills. It is a sign that we now depend on ongoing financial assistance from foreign countries to finance the government’s reckless fiscal policies.” That senator was none other than Barack Obama.

Has Obama’s view changed? I’m thinking yes. In the interest of fairness, I must also ask today’s GOP budget hawks a similar question. Where were they in 2006?

So how will this play out? I hope the GOP and Democrats learned from history. In recent history, the closest parallel is 1995’s government shutdown debacle. You had a first-term Democrat president and a newly-elected, bigger, bolder GOP-controlled Congress. Sound familiar?

In 1995, it was Newt Gingrich leading the GOP Congress against President Clinton. This did not work out well for the GOP. Long story short, Clinton outfoxed Gingrich and the GOP paid for it in the 1996 presidential election when Clinton easily won reelection against Bob Dole. I think the 1995 episode was a big reason Clinton won so easily…well, that and the fact that Bob Dole was not a terribly strong candidate.

Too many current Republicans were around in 1995 and remember it quite vividly. It’s unfathomable to me that they would allow it to go that way again 16 years later. On the other hand, Obama and the Democrats would love to see history repeat itself.

In the end, I think this is going to be largely a non-event (this is part of why I’ve held off on this series of posts since the first one). I also think we’ll avoid default. It’s unfathomable to me that our leadership would be foolish enough to actually allow a default to occur, though I wouldn’t put it past either side, particularly the GOP, to use it as a bargaining chip. My guess is they’ll increase the ceiling enough to make it so that we don’t have to revisit this again before the 2012 elections. Politicians are notorious for crafting “solutions” today that appear to work while in reality not only failing to work, but actually make the problem worse in the future (too many examples to list here). I don’t expect anything meaningful in the way of reform to come out of this, though I do expect some spending cuts and tax increases. Lastly, expect both sides to claim victory and blame each other for not “going further” to address the problem.