Sunday, October 13, 2013

What happens when the debt ceiling is reached?

October 17, this coming Thursday, is the date that the Treasury Department has established as the deadline for increasing the debt ceiling, based on cash-flow projections. That's the day that the federal government is estimated to start having too little cash to pay its bills. That does not mean that the government starts defaulting on bond payments at 12:01AM Thursday morning. But it means that the government would have to start postponing payments on bills and cutting back in a significant way on ongoing federal expenditures. At sometime around the last week of October, the government would apparently have to begin defaulting on bonds.

Here are a few articles looking at the likely consequences if a default happens. Two cautions are in order. One is that nobody can predict exactly how a US government default on bonds will affect the world economy. The dollar is still the only reserve currency for the world. And the rock-solid reputation of US bonds is a main pillar of the world financial system.

The other caution is that the President of the United States clearly has options to avoid defaulting even without Congress raising the debt ceiling: invoking the 14th Amendment to continue financing the government; minting a platinum coin of a $1 trillion or other denomination to fund the government; and, creative bond-issuance techniques that would provide government the funding it needs without technically violating the debt limit. I'm assuming that, faced with a catastrophic default, President Obama will use one of them. Part of the uncertainty here is that if he wants to keep maximum pressure on the Fort Sumter Republicans in Congress to do the right thing by Thursday, not announcing in advance that he will do that is a key element of doing that. (Christopher Matthews discusses those three options in Three Not-So-Crazy Ways Out of the Debt Ceiling Crisis Time 10/05/2013)

Obviously, Obama has a responsibility here. This mess is clearly the fault of the Republican Party by any remotely coherent view. But the newfound Constitutional restraint that the White House has been claiming the last several days that Obama has now embraced should not prevent him from using Executive power - that really is pretty straightforward, especially with the platinum coin option - to save the world economy from the collective derangement of the Republican Party in Congress.

This unsigned Bloomberg View article, Congress's Blueprint for Global Catastrophe 10/10/2013, gives an outline of various consequences of an actual default. Including:

Forced spending cuts will kill the economic recovery. Over the course of a year, the Treasury borrows roughly $1 out of every $5 it spends, so hitting the debt ceiling would require it to cut outlays by about a fifth — and by much more in the short term, because flows into and out of the Treasury are lumpy. Such a severe fiscal squeeze would crush a still-tentative recovery at a time when widespread unemployment is threatening to do permanent damage to the country’s productive capacity. [emphasis in original]
This part is predictable, and to a large extent quantifiable. Conservatives have been whining ridiculously about the debt and deficit making the United States into "Greece." But a default like the Republicans are trying to bring down on our heads, really would put the US into the position of Greece. New, severe budget cuts would tank the already-weak recovery, shrinking the economy and reducing government revenues, which would require further cuts which would further weaken the economy - rinse and repeat, over and over and over. That is what happened to Greece in the euro currency trap and the brutal austerity programs forced onto them primarily by German Chancellor Angela Merkel. It's happening still, not only in Greece but also in Cyprus, Ireland, Italy, Spain and Portugal. Again, this part is predictable. How sudden or severe a new financial crisis would be is less so.

John Glover invokes the "H" word, though not in a goofy way, in U.S. Risks Joining 1933 Germany in Pantheon of Deadbeat Defaults Bloomberg Businessweek 10/13/2013. Again, not raising the debt ceiling would be a statement by Congress that they intend to push the US into default. It does not mean that the US goes into default on Day 1 or that the President has no options to prevent it.

Simon Johnson cautions about the uncertainty inherent in a US debt default scenario in The Debt Ceiling and Playing With Fire Economix 01/24/2013: "The main problem is that no one knows what would happen if the federal debt were to hit its legal ceiling."

Brad Plumer looks at the schedule for catastrophe in A very simple timeline for the debt-ceiling crisis Wonkblog 10/08/2013.

The creative bond-issuance techniques I mentioned are also discussed in:

Matthew Boesler, Everyone's Talking About This Sneaky Solution To The Debt Ceiling That Might Be Even Better Than The Platinum Coin Business Insider 10/08/2013

Matt Levine, Mint the Premium Bonds! Bloomberg View 10/02/2013

Felix Salmon looks at the debt prioritization process in Felix Salmon smackdown watch, debt prioritization edition Reuters 10/07/2013.

David Keohane in US default stripshow FT Alphaville 10/08/2013 gets into some of the consideration the Treasury would be wrestling with in a potential default situation to minimize the immediate damage on the world financial system. Cardiff Garcia does the same: Raise your hand if you know how the Treasury’s payment systems work ... Anyone? 10/06/2013

Mike Konczal checks in with how some of the conservative bigwigs have been analyzing the potential consequences of keeping the current debt ceiling: What are Conservative Experts Saying About Breaking Through the Debt Ceiling? Rortybomb 10/07/2013

Then there's the 600-lb. gorilla on these matters, the Shrill One, Paul Krugman. The title of this October 6 blog post gives an idea of the range of possibilities on the effects of a default, Hitting the Ceiling: Disastrous or Utterly Disastrous?, in which he writes:

... Goldman Sachs has a short paper (not online) arguing that the government probably could prioritize payments on Treasury bills, avoiding the breakdown of markets that would come from putting the world’s key safe asset into default. They don’t sound too confident. But even if they’re right, the government would still go into arrears on many other payments, from contractor bills to medical bills. And it would be forced into savage spending cuts, around 4 percent of GDP, that wouldn't just cause hardship (Surprise! No Social Security for you this month!) but amount to a severely contractionary fiscal policy, sending us into recession if it lasted any length of time.

I think this is important. Lots of people have been focusing on the possibility of a mega-Lehman event, but even if we somehow avoid that, this will be a catastrophe.
He reminds us that we should Blame the Deficit Scolds 10/07/2013. He makes an important point in Deficit Deniers 10/08/2013:

As we close in on the debt limit, with Obama insistent that he will not give in to hostage-taking, there is a growing chorus of voices on the right insisting that the whole debt limit thing is scare tactics from the administration, and that hitting the limit will be no big deal.

And the truth is that there is some real uncertainty about exactly what happens if we hit the ceiling. I think the administration has made a tactical error by putting all the weight of its warnings on the financial consequences; we might have a Lehman-type event, but we might not, and if it turns out not, the administration will have hurt its credibility. What sane people should be emphasizing is that in addition to the risk of financial disruption, there’s the certainty of huge pain from spending cuts and a crippling hit to economic growth. [my emphasis]
And in The Debt Ceiling and the Housing Bust 10/10/2013, he explains the process by which a default scenario would push the United States into a Cyprus/Greece/Ireland/Italy/Portugal/Spain austerity spiral, as income falls short of outlays without the government being able to borrow to close the gap:

This deficit would have to be closed immediately, cold turkey, in the event of a debt-ceiling breach. Probably the default — because it would be a default, even if interest payments are being made — would take the form of a “delayed payment regime“, with the government falling ever further behind on its bills.

So, when did we last see a spending shock this big? As it happens, we’re looking at something just about the size of the post-bubble housing bust, which was also about 4 percent of GDP[.]

You can argue that these spending cuts wouldn't have as much impact as the housing bust, because payment would be delayed, not cancelled, and at least some players would continue to expect eventual payment. On the other hand, as I pointed out in my last post, this time around we would have disconnected the automatic stabilizers — as GDP fell, revenues would fall, forcing another round of spending cuts, and so on.

Again, my point is that we could well be looking at a Great Recession-sized event even if we avoid a purely financial crisis.
If Congress goes with the force-the-US-into-default option and Obama decides to use Executive options to prevent that from happening, the House of Representatives would likely impeach him. But they will probably impeach him regardless, so he might as well save the economy from a self-imposed disaster. Not having another global economic catastrophe works for me.

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