John Boehner, Speaker of the US House of Representatives, is leading the Republican Party’s charge on fiscal policy, arguing that his side needs to see “trillions of dollars” in spending cuts in order for Congress to approve an increase in the US government’s debt ceiling, but framing the issue this way creates a major problem for Boehner: It will directly, completely and quickly antagonize one of the Republicans’ most important constituencies — the US corporate sector.
Focusing on the debt ceiling creates a political trap for Boehner and the Republicans. It is true that the US Treasury’s ability to borrow will reach its legally authorized limit in early August. It is also true that whenever Republicans rattle their sabers about the debt ceiling and threaten not to raise it, the bond market yawns and there is no significant impact on yields.
If the Republicans’ threats were credible, any news that increased the likelihood of a problem with the debt ceiling would send US Treasury bond prices down and yields up. This is not happening, because bond traders cannot imagine that the Republicans would be able — or even willing — to follow through.
After all, the consequences of failing to increase the debt ceiling would be catastrophic. The entire credit system in the US — and in much of the rest of the world — is based on the notion that there are “risk-free assets,” namely US government securities. There is no provision in the US Constitution to guarantee that the US will always pay its debts, but the US has proven itself for 200-plus years to be about as good a credit risk as has ever existed.
US fiscal resolve has been tested at least five times — at independence, in the war of 1812, during and after the Civil War, and in World War I and World War II. We can debate the exact fiscal pressures in each case and precisely how various kinds of bondholders were treated, but the simple fact of the matter is that when the going gets tough, the US pays its debts.
At least in the near term, the chance that the US will not service its debt is vanishingly small — perhaps in the same order of probability as a large meteor striking the Earth. To be sure, there are big fiscal questions to be sorted out — including how much the government should spend and on what, as well as how much tax it should collect and by what means.
There is also the vexing question of how much debt is too much for the modern US. In a world where international investors (from both the private and public sectors) routinely wring their hands about US fiscal deficits — and then go out and buy more US government debt — who knows the answer?
Countries never default because they can’t pay their debts — there are always ways to decrease expenditures or raise taxes. Countries default because their political processes bring them to the point where the people in power decide, for whatever reason, not to pay the government’s debts.
It is not difficult to identify who would bear what costs if the US did not pay — or if it disrupted markets by not increasing its debt ceiling. Everyone who borrows or interacts with the credit system in any way would suffer a shock that would make the crisis of 2008 look small.
Among others, the US corporate sector — big and small business — would be livid. To be sure, executives and entrepreneurs like to shake their heads over the current US fiscal deficit and some of them engage constructively in debates about the real issues — how to control healthcare costs, prevent future financial crises and end expensive foreign wars, but these are the issues for next year’s presidential election, in which one hopes for debates that will set a more encouraging fiscal agenda for the next 20 to 30 years. How and when the US budget problems will be resolved is unknown, but US fiscal history is encouraging — the US has managed and survived crisis before.
Simply put, the US will not score an own-goal over the debt ceiling — and Boehner must know it. Symbolic gestures are to be expected, as with the threatened government shutdown earlier this year, which merely created fodder for political advertising by both parties, but any manufactured debt crisis now would deeply antagonize the corporate sector — and most of the electorate. In the wake of economic disaster, the party held responsible would presumably be exiled from power for a generation (the Great Depression kept the Republicans from the US presidency for 20 years).
The Republican leadership is making threats that are not credible. If the administration of US President Barack Obama plays its hand well, the result will be a last-minute extension of the debt ceiling with no significant concessions. It is unclear how Boehner or anyone else would be able to portray that as a political victory.
Simon Johnson, a former chief economist at the IMF, is co-founder of a leading economics blog, baselinescenario.com, a professor at MIT Sloan and a senior fellow at the Peterson Institute for International Economics.
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