What just happened
Predictably, America seems set to avoid yet another manufactured fiscal crisis.
House Republicans introduced legislation (read the full text here) on Monday that would suspend the debt ceiling until May 19.
The bill is somewhat unusual in that, unlike similar legislation in the past, it does not raise the borrowing limit but waives the cap entirely until the set date in May. As Politico explains, this was fine political maneuvering on the part of Republican lawmakers, who thus avoided agreeing to a “specific dollar amount that could be used against them in campaign ads.”
The draft legislation also contains a provision that would withhold pay for members of Congress unless they pass a budget by April 15 (it is a feat that has eluded the U.S. Senate in the past). The GOP is branding this as a “no budget, no pay” measure, although, in fact, it simply delays paying members of Congress until the end of 2014 at the latest.
The prospect of a likely deal on the borrowing cap spurred a series of bullish bets in financial markets, and U.S. observers around the world are drawing a big sigh of relief.
Rewind: a bit of background on the debt ceiling
What the House Republicans’ bill will likely avoid isn’t so much a full-blown default but a technical default. As Keith Hennessey, who was White House National Economic Council Director under former President George W. Bush, argued last week, a scenario in which the U.S. government would fail to pay bond-holders on time (which would without question trigger a credit rating downgrade and increase America’s borrowing costs, not to mention cause utter panic in financial markets) was never really in the cards.
Rather than threaten the creditworthiness of Treasuries, the government would have likely opted to hold off paying some of its other obligations, such as Social Security transfers, veterans’ benefits, military salaries and all kinds of government contractors. Such a move would still likely cause a credit downgrade—the U.S., after all, would still be failing to pay its bills—but it wouldn’t quite spook investors to the degree a missed or delayed payment on U.S. government bonds would.
In general, though, the costs of defaulting on any of the federal government’s obligations, or coming dangerously close to doing so, are very high. So why does the U.S. have a debt ceiling at all?
In the words of the Congressional Research Service, the debt limit “imposes a form of fiscal accountability that compels Congress and the President to take visible action to allow further federal borrowing.” In other words, it periodically focuses voters’ attention on debt and deficit, supposedly making government more cautious about spending spending levels.
Hennessey, for one, recently argued that the borrowing limit can be a useful tool of political negotiation when “rightly understood,” as Tocqueville would have put it. Rather than pledge not to raise the ceiling—which is a threat so grave it isn’t believable, and also makes Republicans look irresponsible—fiscal conservatives should use short-term raises as bargaining chips to negotiate gradual spending cuts. (Whether or not the GOP heeded Hennessey’s advice or reached the same conclusion by itself, the current debt-ceiling bill seems to be doing just that.)
The vast majority of economists, though, would argue the U.S. should get rid of the debt ceiling once and for all. The measure is a holdover from the interwar period, when Congress, stopped vetting every single spending request by the Treasury and switched to the more practical approach of imposing a generic borrowing limit. But what seemed pragmatic then looks redundant today: Congress already controls the strings of the federal purse through the modern budget process, established in 1974. As it stands, the debt ceiling requires U.S. legislators to debate whether or not to allow enough borrowing to cover financial obligations that it has already approved. At the very least, a number of budget experts argue, decisions on the debt limit should be tied to decisions on revenue and spending.
Besides, the debt ceiling doesn’t seem to have had any influence on the size of the federal deficit.
In recent years, moreover, the debt ceiling is becoming increasingly more difficult to manage. So far, the Treasury has always been able to use a series of account gimmicks to keep honouring the country’s debt for a few weeks after effectively reaching the borrowing limit. With the size of the federal deficit now at $1.1 trillion, though, there is less and less wiggle room for the Treasury to keep paying the bills while Congress ponders a raise, CRS noted.
Fast-forward: What happens next?
Notwithstanding a likely (temporary) resolution to the debt ceiling, there are two more fast-approaching fiscal deadlines:
- According to the Jan. 1 fiscal cliff deal, $110 billion in automatic spending cuts—half of them from defence—will kick in on March 1, unless Congress acts to amend the law. (This is the so-called “sequester,” a shock therapy that would drastically reduce the deficit but also drag down growth and upset powerful constituencies across the country, as I explained here.)
- On March 27, funding for government agencies is set to expire, which will cause a government shutdown unless Congress approves new spending.
The road ahead, in other words, is a minefield of fabricated fiscal crises. And even if Congress and the Administration manage to continue in their dangerous dance without triggering a blow-up, they’re still likely doing damage to the economy.
Policy uncertainty, as the fiscal cliff and the 2011 debt-ceiling showdowns demonstrated, hampers growth by sapping business sentiment and consumer confidence. And the nerve-wracking spectacle of Washington politics could turn off U.S. creditors even if Treasury keeps paying everyone on time. After all, political paralysis is an element of risk, and markets might one day start to price that in.
Besides, as TD economist Beata Caranci noted in the wake of the fiscal cliff law, none of the fiscal battles awaiting us in 2013 will force lawmakers to grapple with the most serious long-term threat to the fiscal sustainability of the U.S. debt: rising healthcare costs.