Yes, fighting over the debt ceiling hurts the economy

Reuters

Steps used by members of Congress to enter the US House of Representatives are empty at the US Capitol in Washington October 7, 2013. As the US Government shut down enters its 7th day, US House of Representatives Speaker John Boehner said that there is "no way" Republican lawmakers will agree to a measure to raise the nation's debt ceiling unless it includes conditions to rein in deficit spending.

Article Highlights

  • Getting too close to the X date causes problems, even if the debt ceiling is eventually raised.

    Tweet This

  • The economy is very fragile, and the labor market is in quite bad shape. The last thing the economy needs is more headwinds created by politics.

    Tweet This

Senators Coburn and Paul took to the airwaves to argue that going past the so-called X date – the date beyond which the Treasury cannot honor all U.S. financial obligations, believed to be sometime in the second half of October – does not automatically mean that the U.S. will default on our debt. Other prominent conservatives have advanced this argument as well.

They are correct. The U.S. could in theory honor our debt obligations while not honoring other obligations, such as Social Security payments, federal-employee salaries, and payments to government contractors. The Treasury could still conduct auctions to roll over maturing securities past the X date, and the Treasury probably could ensure that it has enough cash to pay interest payments on the debt.

But this strategy is not as rosy as many conservatives believe, for a number of reasons.

1. I have read that the legality of prioritizing payments is unclear. I’m not a lawyer, and I don’t play one on TV, so that’s all I will say on the subject.

2. Treasury receipts are lumpy – revenues flow into the Treasury in very different quantities from day to day – and even the possibility that debt obligations may not be honored could seriously rattle markets.

3. IT problems and human error could come into play in a situation demanding such precision.  Indeed, when the Treasury missed a few payments in 1979, part of the reason was trouble with word-processing software.

And that’s not all. Getting too close to the X date causes problems, even if the debt ceiling is eventually raised. We don’t have to reach back into the mists of history to find evidence of this — the summer of 2011 will suffice. Consumer confidence plunged to levels similar to those at the time of the Lehman bankruptcy, and economic-policy uncertainty was as severe as any time since 9/11 – both of which have a nontrivial impact on the economy. In addition, the Bipartisan Policy Center estimates that taxpayers were on the hook for almost $20 billion in extra interest payments due to the perceived riskiness of Treasuries. And the nation’s credit rating was downgraded. Those are all bad outcomes.

Is anything like this starting to happen now? Yep. Here’s a chart produced by Goldman Sachs showing that investors are already showing their concern about the debt ceiling with their behavior on bills coming due soon:

And here's consumer confidence, courtesy of the good folks at Gallup:

The economy is very fragile, and the labor market is in quite bad shape. The last thing the economy needs is more headwinds created by politics. Getting too close to the X date is bad; we have 2011 to prove it. Going past the X date would be even worse, whether or not we successfully honor our debt obligations. And default would likely be a catastrophe.

Don’t believe everything you see on television.

Michael R. Strain is a resident scholar at the American Enterprise Institute.

Also Visit
AEIdeas Blog The American Magazine
About the Author

 

Michael R.
Strain

What's new on AEI

Study: Piketty tax plan would boost equality by making rich less rich. But poor would be poorer, too
image Rep. McCaul’s cybersecurity information sharing center: If you build it, will they come?
image Halbig and its aftermath
image Culture of how Washington pays for medical care
AEI on Facebook
Events Calendar
  • 28
    MON
  • 29
    TUE
  • 30
    WED
  • 31
    THU
  • 01
    FRI
Tuesday, July 29, 2014 | 10:00 a.m. – 12:00 p.m.
Is Medicare's future secure? The 2014 Trustees Report

Please join AEI as the chief actuary for Medicare summarizes the report’s results, followed by a panel discussion of what those spending trends are likely to mean for seniors, taxpayers, the health industry, and federal policy.

Event Registration is Closed
Friday, August 01, 2014 | 10:30 a.m. – 12:00 p.m.
Watergate revisited: The reforms and the reality, 40 years later

Please join us as four of Washington’s most distinguished political observers will revisit the Watergate hearings and discuss reforms that followed.

No events scheduled this day.
No events scheduled this day.
No events scheduled today.
No events scheduled this day.
No events scheduled this day.
No events scheduled this day.