Debt Defying

The first great battle of Biden’s next two years will be the fight over the so-called debt ceiling. The Treasury Department is already implementing “extraordinary measures” to insure we stay under the debt ceiling, but that can only last for a few months. The outcome of this fight may well determine the tenor of the President’s next two years. Biden will be under pressure not to cave to the GOP extortionists’ demands and seek another “grand bargain” that puts even bigger holes in the country’s safety net. McCarthy will be under pressure to extract such concessions in order to satisfy the extremists in his caucus and maintain his position as Speaker. It’s possible, but not likely, we could see a coalition of supposed GOP “moderates” in the House that could buck the extremists and, combined with Democrats, raise the debt ceiling relatively cleanly. Democrats would hope, again probably futilely, that such a coalition could create a basis for progress on immigration and shoring up Social Security and Medicare. It’s certainly possible a deal will be made. But there seems to be an increasing belief, even among those in the know, that this time will be different, and we will actually breach the debt ceiling.

However, before even thinking about the political strategy, the most important thing to note is that the “debt ceiling” is not just a misnomer but a fiction. The actual law that that governs the debt ceiling merely limits the amount of money that the US Treasury can borrow, which it does primarily by issuing new bonds. This is entirely separate from Congress’s responsibility for appropriations, although Republicans love to treat them almost interchangeably. The debt ceiling is purely about paying the bills already authorized by prior appropriations. In fact, these days, the debt ceiling and appropriations process are almost always in conflict with each other, and that conflict is exactly what Republicans want. It allows them to both-sides what they do — cut taxes and then complain about the resulting government debt and demand cuts to social programs.

The GOP has been running this scam for nearly half a century. Reagan criticized Carter for running a $74 billion deficit in 1980 in the midst of two severe oil-induced recessions. But after Reagan’s tax cuts and increased military spending, that deficit had nearly doubled by his departure in 1988. By the time Bush One’s term was ending in 1984, the deficit was $184 billion. Clinton, on the other hand, raised taxes on the rich, eliminated the deficit, and ran budget surpluses for the last three years of his administration, with the 2000 surplus at over $230 billion. Under Clinton, for the first time since the Vietnam War, total government debt was actually reduced, by over $450 billion. Bush Two declared that surplus as “the people’s money” and promptly gave another massive tax break to the rich, the “people” he really represented. Combined with his unfunded two-pronged War in Error in Iraq and Afghanistan, as well as his financial mismanagement that led to the Great Recession, the federal deficit ballooned to over $450 billion. Dealing with the financial disaster that Bush had created meant that the deficit reached over $1.4 trillion by 2009, but Obama was able to bring that down by over a trillion dollars, to under $450 billion in 2015, before seeing it rise back up to $584 in 2016. Trump then passed another unfunded multi-trillion dollar tax cut and, combined with Covid, drove the deficit up to over $3 trillion by the time he left office, incurring nearly 30% of the country’s total debt in just four years. In his two years, Biden has cut that deficit by more than 50%.

Yes, it’s true that there are events that are far beyond any president’s control that will affect the economy. And, yes, when at least one of the houses of Congress is held by the opposing party, any budget will be, by definition, bipartisan, which is why the New York Times can misleadingly describe the growth of the national debt as “bipartisan”. But the reality is that every Republican since Reagan has grown the deficit and every Democrat since Reagan has shrunk the deficit during their time in office. The obvious reason for that is that Republicans constantly pass unfunded tax cuts with mythical promises that they will either pay for themselves or can be offset by some sort of magic asterisk of spending cuts that they never propose, much less pass. Democrats at lease make real attempts to at least partially pay for the programs they pass.

Republicans have been threatening Democratic presidents with breaching the debt ceiling and defaulting on the government debt since the Gingrich revolution of the 1990s. It has never worked, yet they keep on trying. Why? Because the changes that Republicans desire, such as cutting Social Security and Medicare (which is usually portrayed with the banal euphemism of “entitlement reform”) or transferring more of the tax burden from the rich to lower and middle class (which is again euphemistically portrayed as a “flat tax” or “fair tax”), are politically toxic and the hope is that Democrats will help provide cover for actually implementing them.

In fact, in 2011, Obama actually fell for this gambit, offering to combine the debt ceiling and budget negotiations into one “grand bargain” with Republicans that would combine some entitlement reform for higher taxes on the rich. That bargain fell apart because Republicans couldn’t take yes for an answer, instead refusing to raise taxes. In the end, however, Democrats got an even worse deal, spending cuts of nearly $1 trillion and no new revenue for simply raising the debt ceiling by about $1 trillion. Even worse, that deal also resulted in sequestration, which limited both domestic and military spending growth over the next few years with no increase in revenue. Negotiating over the debt ceiling had resulted in a terrible deal for Democrats with virtually nothing in return except an agreement to pay the bills that had already been incurred.

What’s especially worrying about their threat this time is that the GOP is far more extreme than it even was in 2011 and many of their members don’t seem to understand the enormous difference between not funding the government through the appropriations process and defaulting on US debt which will create a worldwide financial calamity. It’s also unclear how many of those members do understand but actually pretend not to care, or are such anarchists they actually don’t care, or are willing to trivialize the consequences.

The consequences for failing to lift the debt ceiling would be severe: interest rates would spike even higher than the Fed-induced rates today; the stock market would collapse along with most people’s retirement plans; there would be a recession; the value of the dollar would collapse; since the US Dollar is basically the world’s reserve currency, world markets would also freeze up, with massive unknown but probably disastrous consequences, as well as a rethinking of the Dollar’s place as a reserve currency; and it would result in higher future borrowing costs for the US — the 2011 standoff resulted in a downgrade of the US credit rating. As economist Mark Zandi says, it will be “financial Armageddon”.

Some Republicans float the idea of “avoiding” default by having the Treasury prioritize the payment of bondholders. This is another GOP fantasy, since it would require a massive restructuring of the Treasury payments system which is designed to send out payments as they are due. In addition, it is actually unclear whether Treasury has the legal authority to prioritize payments. The idea of paying foreign bondholders while withholding Social Security checks from Americans is also political suicide. Every creditor who does not get paid under prioritization will have a claim against the US Government and any revenue it brings in, probably resulting in any payments being legally challenged and perhaps even frozen by courts. Finally, the debt markets are not stupid and will recognize prioritization as default under a different name.

A bigger problem is that McCarthy has already proven he has no ability to control his caucus and no one, especially Democrats, should take his word he can deliver the votes when he says he can. In fact, House Republicans can’t even agree on what they even want for a debt ceiling increase. They have floated cutting Social Security and Medicare; a 30% sales tax; cutting the ACA; cutting defense; expanding defense; defunding the FBI and/or DOJ; ending the Covid public health emergency; border security; and more tax cuts for the rich and corporations. Other can’t even name a specific program they’d like to cut.

Most of these proposals are already political losers and Republicans are already backing away from them. McCarthy, at least for today, has taken Social Security and Medicare cuts off the table. Republicans are disowning the 30% sales tax. But the details of the specifics are not what’s important to the GOP right now. For them, the first step is getting Biden to agree to negotiate at all, which will open up Pandora’s box for all the crazies in the Republican House.

Thankfully, Biden appears to have learned the lesson from 2011 and is refusing to negotiate over the debt ceiling, simply demanding that it be expanded in a clean vote. And Democrats are so far sticking to that line. Yes, Joe Manchin has floated a plan to link raising the debt ceiling with a plan to shore up the Social Security and Medicare, but the plan he envisions is to raise the income limit on payroll taxes, a non-starter for Republicans. And Josh Gottheimer, the Democratic member of the Problem Solvers (read problem creators) Caucus who sabotaged Build Back Better, is proposing setting the debt ceiling as a percentage of GDP, an absurd solution that simply replaces one arbitrary number for the debt ceiling with another and would undercut the government’s ability to effectively combat economic disruptions like we saw in 2008 and 2020. Some Democrats worry about Biden’s resolve, noting that both he and new White House Chief of Staff Jeff Zients were heavily involved in the disastrous 2011 giveaway, so much so that Harry Reid ensured that Biden had no role in the 2013 budget negotiations. But the majority of Democrats support Biden’s position that the answer to McCarthy’s demand for debt ceiling negotiations is “you get nothing”.

Standing firm on the debt ceiling has already been a good strategy for Democrats. It has exposed the unpopularity of the Republicans’ proposed cuts to Social Security and Medicare. It has focused attention on their willingness to raise taxes on the less than 1% to give even more money to the 1%. It has exposed their inability to even articulate a positive policy agenda. And it has highlighted the disarray within the GOP caucus and its inability to actually confront the real problems facing this country.

Breaching the debt ceiling puts the President in a conundrum. If he ignores the debt ceiling, he is violating the law regarding financing limits. If he unilaterally cuts spending, he is violating the constitutional requirement that controls spending. But there are a number of potential options for avoiding a breach of the debt ceiling that Biden could unilaterally take. We have already mentioned the idea of prioritization of payments to bond holders. This, apparently, is an option that some on Wall Street believe will create the least financial chaos. Another option is for the Federal Reserve to buy back some of the current cheaper, lower interest bonds before their maturity, thereby reducing the outstanding debt. The Federal Reserve could also start issuing interest-only bonds with no principal. Because there is no principal attached to the bonds, there would no addition to the debt, but those issuances would still raise money from investors willing to purchase that income stream. A more popular option is what’s known as “minting the coin”. Using a 1997 law that allows the Treasury to raise money by issuing novelty coins, the Treasury could mint the “how ever many trillion you want” coin and then use that “money” to fund its obligations without issuing any new debt per se.

All of these are accounting and financial gimmicks that would probably do little to dampen the chaos in the markets if there is no real agreement regarding the debt ceiling and many of them would only provide temporary relief. The more principled and more constitutionally sound option is to simply declare the debt ceiling unconstitutional, citing Section 4 of the 14th Amendment which states, “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.” As Jamelle Bouie notes, this amendment was ratified in 1868 and was specifically written by Congress to avoid a situation where a future Congress would simply invalidate the public debt. Their specific fear in that post-Civil War period is that Southern Democrats and their allies would invalidate the debts of the Union.

Unfortunately, Biden and Democrats as a whole have refused to contemplate any unilateral action regarding the debt ceiling. They had a chance to raise it or abolish is when they had control of Congress for the last two years and they didn’t. Biden has repeatedly refused to consider eliminating it. If we had two normal parties, we would probably see some political posturing, some small concessions, and a smooth and uncomplicated raising of the debt ceiling. And that may happen again this time, as it has so many times in the past. Indeed, there are already some rumblings among so-called “moderate” Republicans in the House that that’s exactly what should happen. It would not be surprising to see Biden make some small concessions and 50 or 60 of those GOP House members, along with all Democrats, would provide the votes necessary to raise the debt ceiling, leaving the 150 or so of the crazy caucus to continue to pander to their extremist base.

But the reality is that we don’t have two normally functioning parties in this country anymore. So, we are once again faced with the GOP playing a game of chicken with the world economy in the balance. Biden (hopefully) understands that if he starts making any significant concessions on the debt ceiling, the extortion demands will increase, and he will emerge even weaker when the budget needs to get negotiated later this year. In addition, he cannot rely on McCarthy to accurately represent his caucus. McCarthy, on the other hand, has to worry that not receiving any significant concessions will mean the end of his speakership. In addition, the last six years have shown that Republican “moderates” often talk a good game but then fold to the extremists in their party.

In the old Republican party, business leaders would talk the party down from the ledge. But, like GOP “moderates”, today’s business leaders not only have far less sway over the party but also seem unable or unwilling to take on the extremists. In fact, it is shocking to hear some on Wall Street believe that prioritization is actually a workable scheme. It only highlights their belief that this time, we may finally breach the debt ceiling. On the other hand, the consequences of finally breaching the debt ceiling may also further illustrate to those not in the epistemic closure of conservative media that today’s Republican party can never again be entrusted with any power.

Originally published at https://thesoundings.com on February 1, 2023.