How to evaluate the possibility of a voluntary default of the most important country in the world? Is something that crazy really likely to happen? What could be the consequences if it did? These questions are impossible to answer. This is not because it is a “black swan”, i.e. unimaginable. A US default, on the other hand, falls into a broad category of “known unknowns”, ie unpredictable, high-impact events. The 2007-09 financial crisis, the pandemic, and the Russian invasion of Ukraine were of this type.
Such events are impossible to predict 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 emerge, when and where someone will start a war, or whether US politicians will destroy their country’s accumulated credit over the centuries. Yet we know such shocks happen. They are part of our reality.
So, what about this specific threat? It is not normal for a country to have a regulated budget and a separate authorization for the debt that this budget entails. For the US, this was a product of the needs of war: before 1917, Congress had to authorize every single loan. Until now, the US debt ceiling has always been raised when needed. It has apparently happened about 90 times.
Reasonable people would conclude that the ceiling is nonsense. But it is not an irrelevance. Increasingly, Republicans see the cap as a lever on spending but not, it should be stressed, on deficits caused by tax cuts. They were happy with the latter under George W. Bush and Donald Trump. Thus, as “explainerof the Brookings Institution notes, “Over the past three decades, the limit has precipitated political battles during which some lawmakers have used the debt ceiling vote to try to slow the growth of federal spending.” This happened under Barack Obama in 2011 and under Joe Biden in 2021, before the debt ceiling was raised to where it is now at $31.4 trillion. The need to lift it once again has become very urgent because the federal government could do it run out of cash in June.
Could default occur? The answer is yes.” One reason is that the parties are far apart. The Republican proposals would mandate a 47 percent cut in total real non-military discretionary spending between 2024 and 2033. That’s a huge gap to close, although the mood music could improve. The other reason is that key participants may feel they have no incentive to compromise. Republicans are very testy, some have extremely radical views, and many seem to feel that even an economic disaster would only hurt the administration. Meanwhile, Democrats may feel that giving in to spending is too painful. In chicken games like this, collisions happen.
Some hope this can still be managed, at least for a while. The 2011 plan would have meant maintaining interest and principal payments, but delaying payments to agencies, contractors, Social Security recipients and Medicare providers. More radical proposals concern a trillion-dollar platinum coin or the use of the 14th amendment, which States: “The validity of the public debt of the United States, authorized by law . . . it will not be questioned.” With today’s Supreme Court, one has to doubt that that would work.
Think of all the people, institutions and countries that hold Treasuries as the safest and most liquid assets in the world. Even a brief interruption in payments could be devastating to confidence, not just in Treasuries, but in capital markets. The possibility of a default can be dismissed as unreal. One’s experience would surely be all too real.
Beyond that, it would be a huge shock to trust the United States. Michele Stump of the conservative American Enterprise Institute says that “foreign leaders and global investors would look at the United States and see a damning portrait. In this corrupt 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 fulfilling government financial obligations. Investors would think more about allocating capital to US entities, and America’s role as a beacon of liberal values, including free markets, would be severely undermined.” Quite simply, they would conclude that the insane had taken over the asylum.
Even if the worst is avoided this time, repeated plays of this game of chicken cumulatively make it more likely that the crash will actually occur. Glenn Hubbard, former head of Bush’s Council of Economic Advisers, has made reasonable proposals. What is really needed is a long-term solution, in which the theatrics of the debt ceiling are replaced by a coherent long-term budget. The current trajectory of US debt makes such proposals necessary.
However, against this is the fact that the efforts of Democratic presidents, such as Bill Clinton and Obama, to reduce potential deficits have simply allowed Republicans to cut taxes when they return to power. That said, will there be the political will to put the country’s needs before partisan advantage? Nor is this an equal failure. Republicans are heavily to blame. They are using default threats to get spending and tax cuts, rather than deficits, for which they have not been able to win decisive election victories.
In the end, “It’s politics, stupid.” The only reason a default is conceivable is the depth of disagreement in the country and therefore in Congress. If the US were less divided, the debt ceiling wouldn’t matter. In today’s divided United States, yes. As long as these divisions continue, the threat of a default will continue as well. Even if a temporary deal is reached, the threat is likely to resurface soon.
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