Potentially Big Dangers of Dancing With the US Debt Limit

To understand the absurdity of the loan limit, let’s recall its origin. The statute that created it was adopted in September 1917, authorizing the issuance of bonds to aid America’s entry into World War I. It was designed to reassure opponents of American involvement in the war as to how far the limits were. The country will go

The US Constitution gave Congress the power to micro-manage Treasury borrowing, something that was impractical in times of war. Therefore, the legislators handed over this power to the President. But to pacify those who opposed any expansion of executive powers, as well as German-Americans opposed to going to war with Germany and Irish-Americans, the 1916 Easter Rising for that country’s independent Ireland After the violent repression of the British, Congress placed a limit on that borrowing.

For more than a century, forgotten grievances pose a dilemma facing the United States of America today. absurd is right.

So far, the Congress has always managed to avert the worst. Even in 2013, a year of partisan rancor, Democrats and Republicans agreed to suspend debt limits just a week before the Treasury, already unable to borrow, ran out of cash reserves. But this year may be different.

Most clearly, the political polarization is far greater than it was in 2013. Norms of political behavior—including the idea that both parties must cooperate to avoid a predictable disaster—have gone out the window since the January 6 attack on the US Capitol by supporters. Then-President Donald Trump K. In the after-fact world, Republican members of Congress, even if they are actual agents of a disaster, can always blame — at least in the eyes of the Republican base — Democratic legislators and their free-spending ways.

Failure to raise or suspend the loan limit will result in an immediate government credit-rating downgrade. If US Treasury debt loses its investment-grade rating, institutional investors will be barred from holding it by their mandate, while foreign investors, including central banks, will think twice. US borrowing costs will rise.

Some studies suggest the dollar’s safe-haven status saves the Treasury upwards of $700 billion in interest payments over a decade — ironically enough to fund nearly three-quarters of the bipartisan infrastructure package. Is. There is already some evidence of this bonus being lost.

Uncertainty, as the COVID crisis has reminded us, is what investors fear most, and uncertainty will increase with interest-payment suspensions of unknown duration. The stock market will react negatively. In addition, because Treasury securities are used as collateral in a wide range of private financial transactions, the short-term funding market would be crippled if the Treasury was forced to suspend its interest payments. Withdrawals would force money-market mutual funds to engage in fire sales of Treasury bills and potentially suspend redemptions. Estimates of the economic fallout range from profound damage to catastrophic. A representative forecast shows that GDP will decline by 4%, while unemployment will rise to 9%.

The Fed will certainly act, as it does in every crisis. This will activate the emergency measures discussed for prior credit-limit crises. It will buy defaulted Treasury securities and accept them as collateral in its own lending operations, albeit at their now-low market prices. But it would put the Fed on thin ice. It will find itself in the middle of a political struggle. Democrats will criticize it for shielding Republicans from the consequences of their inaction. Republicans will accuse the Fed of colluding with the Democrats’ alleged “socialist” agenda.

Astute analysts suggest that all of this could be avoided if the Treasury only made interest payments first. It can continue to pay them in full when tax revenue comes in, while cutting other outlays by 40%. But it poses formidable technical problems (think re-programming government computers). And if you believe that Congress would be willing to cut Social Security benefits and military pay in order to bail out bond holders, you live in a political fantasy.

There is some hope left. Senate lawmakers could allow the debt-limit increase to be linked to a reconciliation bill passed along party lines. Democrats can barely swallow and vote on a basis that holds true for America regardless of the election results.

Or the Republican holdouts may reconsider given the gravity of their actions. Recall how, in the wake of the global financial crisis in 2008, Henry Paulson, the then US Treasury Secretary, went down on one knee to beg the leadership’s support after Congress rejected a $700 billion bailout. He succeeded, and the House passed it on a second attempt with votes of Democrats and Republicans. But don’t hold your breath. The obstinate congressman was then Democratic House Speaker Nancy Pelosi. Today, it is Republican Senate Minority Leader Mitch McConnell. ©2021/Project Syndicate

Barry Eichengrin is Professor of Economics at the University of California, Berkeley. He is the author of several books including the upcoming ‘In Defense of Public Debt’.