Update 662 — Weaponizing the Debt
House GOP’s Cause: Whose Default?
The Full Faith and Credit clause of the 14th Amendment to the U.S. Constitution states that “[t]he validity of the public debt of the United States, authorized by law… shall not be questioned.” With good reason, given debts incurred in waging the Civil War, and much more today, the U.S. dollar is now the world’s reserve currency.
Yesterday, the nation hit its statutory debt limit of $31.4 trillion. But the House GOP seems unaware of, or indifferent to, the economic calamity that would follow from default by the U.S. government on any of its debts. Will House GOP members vote to raise this limit before a default? After all, enough of them did so when Trump was president. Or, will they demand a policy price for their vote, a tactic that led S&P to downgrade the U.S.’s credit rating for the first time in 2011, and, ironically, a massive increase in deadweight interest expense. Read on.
Good weekends all,
Treasury Secretary Janet Yellen announced in a letter to Speaker Kevin McCarthy yesterday that the Treasury began taking extraordinary measures in order to increase the time the agency has left before the U.S. hits the statutory debt limit. As of yesterday, the limit was reached, and the clock is ticking on Congress to raise or suspend the debt limit. Failure to do so by the time the Treasury exhausts its options would risk a default on its debt for the first time.
As part of the extraordinary measures, Treasury will redeem old investments and suspend new ones in the Civil Service Retirement and Disability Fund and the Postal Service Retiree Health Benefits Fund, as well as suspend reinvestment in the Government Securities Investment Fund of the Federal Employees Retirement System Thrift Savings Plan. This plan will temporarily reduce the amount of Treasury’s outstanding debt and buy some time for Congress to act. Temporarily suspending these investments will not negatively impact the funds’ beneficiaries in the short term. Once the crisis has passed, the Treasury will reinvest in the funds to make them whole, plus any interest that would have otherwise been earned under full investment.
Extraordinary measures will stave off default until at least June 5, says Yellen, though the exact amount of time that these measures will buy is uncertain.
With Republicans in control of the House, some options for raising the debt limit that might once have been available– like using reconciliation or employing the Gephardt rule– are no longer on the table, complicating efforts to overcome opposition to a clean debt limit bill in Congress.
Staring into the Abyss, Again
The position the country finds itself in is growing increasingly familiar. The most harrowing showdown over the debt limit in recent years occurred in 2011, when a standoff between President Obama and House Republicans brought the U.S. near enough to default to shake confidence in the government’s ability to manage the debt limit. During this episode, S&P downgraded the United States’ credit rating for the first time.
Republicans also extracted policy concessions in the 2011 Budget Control Act in exchange for raising the debt limit. Among them was a system of discretionary spending caps which remained in place through Fiscal Year 2021. The repercussions of these spending caps are still felt more than a decade later as key government agencies have struggled with years of real budget cuts and expanding mandates.
While 2011 stands out as the prime example of debt limit fights, the last twelve years have not been free of debt limit debates, as the Treasury has now had to resort to extraordinary measures nine additional times since.
The mere threat of default can have severe political and economic consequences, as it did in 2011. Actual default would be catastrophic, sending shockwaves through global financial markets and triggering a recession.
The U.S. dollar currently operates as the world’s reserve currency. Default would shake the global financial system’s faith both in the dollar and in Treasury bonds, regarded as one of the safest assets in the world. Failure to address the debt limit could eliminate global confidence in the U.S., not because the federal government is incapable of meeting its obligations, but because its own rules prevented it from doing so.
The Treasury would also face higher interest rates as a result of lost confidence, which both raises the cost of debt servicing for the federal government and leads to higher interest rates for Americans looking to take out loans.
When the Treasury no longer has the ability to meet its daily obligations, there will also be massive repercussions for the federal government’s ability to function. A default is not the same as a government shutdown, where essential workers remain on the job and programs critical to the health and safety of Americans keep operating. If the federal government can’t meet its obligations, everything from Social Security and Medicaid to school lunch programs and air traffic control could be at risk.
In 2021, Moody’s Analytics estimated that a protracted default would cause economic damage on par with the 2008 financial crisis. Under their model:
- Real GDP would decline by nearly four percent
- The U.S. economy would lose almost six million jobs
- Unemployment would rise to nearly nine percent
- Stock prices would plunge, erasing nearly $15 trillion in household wealth
On top of this, the global financial system would face severe, lasting damage both for households and the macroeconomy.
The Perils of Prioritization
Republicans are hoping to reprise their 2011 victory this year by holding the debt limit hostage in exchange for cuts to programs like Social Security and Medicare. As part of a side deal in his contentious battle for Speaker, Kevin McCarthy agreed to pass a payment prioritization deal, which would likely direct the Treasury to keep making interest payments on the national debt, send out Social Security checks, and keep funding rolling for Medicare, veterans’ benefits, and the military.
But payment prioritization is not as simple as it seems. The Treasury deals with a complex, mountainous system of payments every day, so sorting through them to determine who gets paid and who doesn’t is not a simple task. Payment prioritization would be a short-term fix and would risk market confidence in the government’s ability to meet its obligations would plummet, spooking the markets and sending interest rates soaring, while choking off funding to essential government programs.
But some Republicans believe that going to the mat over the debt limit in the name of cutting federal spending will be a winning issue for them. A serious miscalculation. The debt ceiling is not generally well understood by the public, who struggle at times to understand both what the debt limit is and why the government can’t seem to keep below it. The public will be materially hurt and not politically fooled.
The White House has held firm that the administration will not negotiate over the debt limit. The consequences of the budgetary caps extracted during negotiations in 2011 highlight the consequences of allowing the debt ceiling to be used as a bargaining tool. Ceding broad spending cuts that would slash Social Security and Medicare would have significant and long-lasting consequences for the American people.
Some scholars and pundits have been throwing around last-ditch ideas for actions by the administration to circumvent Congressional inaction– like minting the trillion dollar coin, invoking the 14th Amendment, or issuing premium bonds. These options, however, are broadly regarded as gimmicky at best and of dubious legality at worst. The safest option that poses the least risk to the U.S. economy– barring eliminating the debt ceiling entirely– is simply for Congress to act to raise or suspend the debt limit.
Lawmakers must eventually find a permanent solution to the debt limit that doesn’t give Congress the ability to play chicken with the creditworthiness of the United States. But in the meantime, both Congress and the White House will need to do whatever it takes to avoid the worst-case scenario of default without conceding on ripping up the social safety net, imperiling 401(k)s, and immediate recession, if not depression. The debt ceiling is a risky political battle for the House GOP. With McCarthy commanding only a narrow majority that can topple him at any time, even members who call him a friend predict the showdown won’t end well for him. “It will cost Kevin his job,” said Sen. Kyrsten Sinema (I-Ariz.).