Debt Ceiling Tea Leaves

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Nobody knows what's going on.  The President wants a grand bargain, Boehner wants a smaller deal with no new revenues, the Tea Partiers want to turn America into an agricultural backwater with nuclear weapons and the so-called Gang of 6 unveiled a proposal that everybody wants to talk about and nobody would actually vote for.  So how do regular folks, you and me, get some kind of handle on this whole Debt Ceiling kerfuffle and what it might mean to us?  Well, let's forget about the process and think in terms of outcomes.  There are, ultimately, only three possible ways that this all ends.

1.  Some kind of stroke-of-midnight deal is made, either with a deficit reduction package attached or just a clean increase in the debt ceiling, before the August 2nd econopocalypse.

2.  August 2nd arrives, the market freaks out, everyone panics and comes to their senses and they raise the debt ceiling almost immediately - say, within a week of the freakout, whenever it actually happens.

3.  The deadline comes and goes, the markets freak out, perhaps blow up, and STILL the US House of Representatives is unable to pass a new debt ceiling bill.  The standoff lasts for a month, perhaps several, with the US and the world adjusting to a 'new normal' where US government spending is cut nearly in half, interest rates spike, freezing up credit markets and the dollar collapses relative to other currencies.

There you have it - pretty much the whole universe of possibilities for the next 60-90 days.

The first outcome would, obviously, be the best by far.  It would establish that we are governed by partisan fools, but not madmen.  There would be some economic fallout, but nothing close to catastrophic.  The long term negative effect will be to firmly establish apocalyptic brinkmanship as part of our political process, ensuring that others will again take the entire system hostage and threaten to blow it all up.  Eventually, someone will.  But at least it wouldn't be now.

The second has real costs - to a lot of individuals who need their pension income, their health benefits, their housing assistance.  The economic costs would be significant - most debt instruments, from US Treasuries to Municipal bonds to credit cards would carry a higher interest rate for the foreseeable future, an artifact of the higher 'risk premium' that would be built into US debt going forward.

The third seems unlikely at this point.  The conventional wisdom is that the powerful financial interests have influence over the Republican party, and can somehow coerce them into accepting the kind of compromise they have repeatedly rejected to this point.  But it remains an open question whether those same traditional Republican constituencies have that level of influence with the radical right-wing true believers in Congress, along with those more fearful of a Primary challenge from the right than the of the threats of the traditional funding base.

But unlikely though it may be, it cannot be ruled out at this point.  It would be a historical event, changing nearly everything in one or two mid-summer months in 2011.  Think of it as a sliding scale of economic disaster - the longer the House Republicans resist a compromise deal, the worse both the short term and long term outcomes will be for all of us.

Recession?  Depression?  "Contagion" leading to the collapse of the Eurozone?  Plummeting global trade numbers, falling GDP in China leading to unrest, falling energy and commodity prices leading a brutal deflationary cycle, US unemployment over 20%?  When you think about what a bloc of elected representatives are willing to put at risk in order to advance an unpopular ideological agenda, you are forced to confront just how badly broken our system has become.  It makes a certain sense, though, as a system carefully designed in the late eighteenth century would be expected to lack the flexibility and adaptability to adjust to twenty first century changes in technology and society...
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