Story by Special to Financial Post •
Senate Majority Leader Chuck Schumer (D-NY) attends a news conference in Washington, criticizing Republicans for what he called brinksmanship and irresponsibility over the debt ceiling. Politics is driving the U.S. to the cliff’s edge., writes Eric Miller.© Provided by Financial Post
We live in an age when the unthinkable becomes thinkable. In the field of public finance, another “unprecedented event” is on the horizon.
If Congress does not raise America’s statutory borrowing limit – known as the debt ceiling – the United States will default on its obligations, including to bondholders. The U.S. is the world’s largest economy, and the dollar is the global reserve currency, meaning that the consequences of a default would be seismic.
At present, the U.S. debt ceiling stands at US$31.4 trillion. On Jan. 19, 2023, Treasury Secretary Janet Yellen s ent a note to House Speaker Kevin McCarthy informing him that United States had reached its borrowing limit. Her department is currently using “extraordinary measures” to temporarily cover expenses, but this spare cash will be exhausted by June 5, 2023, after which the U.S. Government would default.
Despite battles in 2011 and 2013, Congress has typically raised the debt limit without incident. After all, borrowing pays for expenses already accrued.
Yet, this time, the new Republican majority in the House of Representatives is refusing to raise the debt ceiling without major cuts in government spending.
The last time the U.S. had a balanced budget was 2000. Since that time, four Presidents – two from each party – have added US$25 trillion in new debt. Under the simplest measure – on whose watch the spending occurred – responsibility is split evenly between the parties.
There is no doubt that the long-term debt picture for the U.S. is not good, but it has not reached a crisis point. If Congress raised the debt ceiling tomorrow, Treasury would have no difficulty in selling its bonds.
Rather, it is politics driving the U.S. to the cliff’s edge.
Republicans took control of the House in January with very slim margins. This empowered the Party’s hardened populist wing.
Their first exertion of power was over the selection of the House Speaker – the top position in the Chamber. Normally, this is a simple process. This time, the populists put Kevin McCarthy – the Republican leader – through 15 rounds of voting before giving him the nod.
With each round, Mr. McCarthy offered yet more concessions, including the dilution of his own power to drive consensus on difficult issues. One of the key concessions was a commitment not to raise the debt ceiling without major spending cuts, even if this means defaulting.
To date, Republicans have not agreed on nor tabled a specific list of cuts sought. They also will not raise taxes. Math and politics make balancing the budget really hard.
Nevertheless, many analysts think the whole point of the debt ceiling fight is to excite the Republican base about “government overreach,” as exemplified in laws such as the Inflation Reduction Act.
Regardless of political posturing, the fact remains that the debt ceiling must be raised.
Yet, this imperative is being met with a troubling tendency to downplay the risks that default would pose to the U.S. and global economies.
At present, the U.S. benefits from the market belief that there is a 100 per cent chance that it will pay its debts on time and in full. If that belief is invalidated, interest rates will spike dramatically.
In 2021, Moody’s Analytics modelled a U.S. debt ceiling default. They found it would cost 3 million jobs and wipe out $15 trillion in household wealth. In other words, it would create a repeat of the Great Recession.
Many advocates of brinkmanship are also postulating a difference between a debt default and a “default on obligations.” The idea is to “prioritize” payments to bondholders over other obligees, including pensioners, soldiers, and contractors, thus formally avoiding default. For its part, Treasury says this “prioritization” is unfeasible.
In the end, solving this looming crisis will take leadership. Given his political weakness and specific commitment to “go to the edge” on the debt ceiling, there are real questions about whether Speaker McCarthy could even deliver his caucus on a deal to avoid default.
In the coming months, Canada and others around the world will watch the economic consequences of political polarization play out in real time. If the U.S. does default, we are likely to see an economic earthquake, including the end of the dollar’s hegemony and the system it underpins. While we should all hope this does not happen, it is time for investors and governments to start planning for the worst.
Eric Miller is President of Rideau Potomac Strategy Group and a Fellow at the Canadian Global Affairs Institute.
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