Debate Club

All Sides Must Appreciate the Risks of a Debt Default

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The surge in optimism late last week has given way to pessimism over the holiday weekend. The government remains closed for the first time in 17 years. The Treasury continues to warn that it is days away from running out of financial wiggle room. The Senate appears deadlocked. The president is simply AWOL.

The stakes are high. To date the partial shutdown has inflicted little significant damage to economic growth, but breaching the debt limit carries the very real risk of financial conflagration. The only argument to the contrary is that the Treasury could somehow "prioritize" to pay interest, thus avoiding a formal default, and that financial markets would be assuaged by this bureaucratic legerdemain.

Wrong, on both counts. The computer software and systems needed to engineer this scheme could not possibly be operational in time; even if it was, financial markets would still recoil in horror. The basic question that lenders ask is whether the borrower is financially capable of meeting the obligation to repay, with interest. The spectacle of a country unable to pay Social Security, Medicare, energy contractors, highway construction, food stamps or other obligations – even though their interest costs are kept current – would undermine that confidence. The result would be loans only at the higher interest rates charged to the riskiest borrowers. The economic headwind of higher interest rates would exacerbate the already-disappointing pace of economic recovery.

[See a collection of political cartoons on the budget and deficit.]

If confidence in the U.S. dipped enough, Treasury securities could actually trade below par, at less than a dollar-per-dollar of face value. At that point there will be a rush for the exits, market chaos, and the dollar will cease to anchor global financial markets. Not exactly a good objective for public policy.

Time is increasingly in short supply. The consequences of running over the debt limit are so severe that it is mystifying that the president is willing to remain on the sidelines as the U.S. approaches it. Prudence would argue in favor of getting a deal in as timely a fashion as possible.

Both sides need to accept the fact that negotiating a deal is necessary. The government is both divided politically and populated by elected officials representing widely divergent policy views. These legitimate differences can only be bridged by principled compromise borne of negotiations. A naïve belief by the House, Senate, or White House that they can "not negotiate" or "hold out" for its position is simply dangerous.

It would also be at odds with history. Largely because divided government is more the norm than the exception, debt-ceiling increases typically are accompanied by legislation intended to control the rising debt. Which, it should be noted, remains the real problem even after the debt limit is increased.

[See a collection of political cartoons on the economy.]

Finally, a deal is not hard to imagine. Any so-called "grand bargain" is simply a bridge too far. But a small scale reform to so-called "mandatory" spending – entitlements like Medicare, farm programs, unemployment insurance and so forth – could easily generate enough savings over the next 10 years to relax the pressure that has been placed on defense and non-defense spending by the sequester, lower overall future spending and debt, and provide headroom for a sizeable debt limit increase. It would also have the added benefit of sending a signal to the rest of the world that the U.S. is finally starting to get financially responsible.

Democrats would get what they want – a more robust near-term domestic agenda. Republicans would get what they want – strong defense and a shift in focus to the fastest-growing part of the budget. And the president would eliminate debt limit drama during 2014.

The turmoil in Washington is troubling. It is time for all sides to appreciate the economic risks, respect the need for compromise, and quickly reach a deal. 

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  • Douglas Holtz-Eakin

    About Douglas Holtz-Eakin President of the American Action Forum

    Tags
    economy
    deficit and national debt

    Other Arguments

    #1
    7 Pts
    Breaching the Debt Ceiling Will Cause A Mess, One Way or Another

    No – Breaching the Debt Ceiling Will Cause A Mess, One Way or Another

    Michael Madowitz Economist at the Center for American Progress

    #3
    3 Pts
    A Debt Default Is Serious, But Not the End of the World

    No – A Debt Default Is Serious, But Not the End of the World

    Dean Baker Codirector of the Center for Economic and Policy Research

    #5
    -4 Pts
    There Are Options to Avoid a Debt Ceiling 'Default'

    Yes – There Are Options to Avoid a Debt Ceiling 'Default'

    David Schweikert Republican Representative from Arizona

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