Saturday, January 5, 2013

America's Next Economic Crisis - A Continuing Series

These days it's much harder to write a ransom note.
You have to cut the letters out of the screen..
America's appalling inability to govern itself has come to manifest itself in a series of crises, where the lying and posing and intransigence lasts right up to, or typically even shortly after, the last possible moment, whereupon some band-aid agreement is reached that defuses or at least postpones the crisis without addressing any of the larger issues.  The fact that our political leadership fully recognizes this dysfunctional dynamic is evidenced by the fact that these serial crises are entirely artificial in nature, unnecessary artifacts of the attempts of a failed institution to force itself to act.  Last week, a basic question of tax policy took our nation's economy to the brink, before being resolved in a simple and rational adjustment to the tax law.  Of course, Congress still found itself paralyzed and unable to solve the other half of the "Fiscal Cliff" crisis, the sequestration cuts that were intended to create an artificial crisis in the first place.  These pointless, irrational across-the-board cuts were merely postponed for two months, leaving them to become part of the next unnecessary, artificial crisis, the much steeper economic "cliff" represented by the debt ceiling.

If there's any anomalous artifact of America's massive failure of governance that leaves other nations shaking their heads in wonderment it is the debt ceiling law.  It's not enough that Congress controls the purse strings, being the sole government body that can authorize spending and the collection of sufficient revenue to cover the spending they order.  To a large degree, the Executive Branch merely exists to administer the spending ordered by Congress.  And of course, being not just a single dysfunctional body, but rather two dysfunctional bodies with opposing majorities and substantially different constituencies, Congress has long found it impossible to responsibly raise sufficient revenue to cover their appropriations.  This does not relieve the various agencies of government from their obligation to carry out the spending legislation passed by Congress, so they are left with a revenue deficit they must cover by borrowing money.  But of course, Congress didn't stop there.  They passed yet a further law, this one placing a hard cap on the amount of debt the government can issue.  This puts the government in the impossible position of being legally obligated by Congress to spend money they are legally prevented by Congress from raising.

And, inevitably, we find ourselves at that point again.  The Republicans in Congress, unable to pass their unpopular, destructive and toxic legislative agenda any other way, are now going to hold the entire global economy hostage, promising to wreck it if they don't get their way.  Unfortunately, President Obama has consistently felt he was obligated to play the role of the "adult in the room" and give in to these sorts of ultimatums in order to prevent serious damage to the economy.  But even as the Republicans believe he will once again acquiesce to save "the hostage", he seems to recognize the long term risk to America's well being, not to mention his own legacy, brought about by his willingness to negotiate under these terms, and is loudly promising a flat refusal to negotiate to raise the debt ceiling.

So what happens next?  Well, the American government still has its regular sources of revenue.  The funds that the Treasury is blocked from raising are those required to close the deficit, the difference between what is to be spent and the revenues available.  If we assume the deficit this year is a trillion dollars, that would mean a shortfall of about 80 billion dollars a month, or about 6% of GDP.  That's HUGE, and the President will have to figure out who gets paid and who doesn't.  If a US default is considered the worst outcome, that can be avoided.  And it would only make sense that the President would allocate funds in such a manner as to bring the maximum pressure to bear on Congress to simply raise the debt limit.  That would mean issuing IOUs to defense contractors, government vendors and consultants, and furloughing non-essential government personnel.  It would mean an immediate cut-off of aid to states, and a sharp reduction in government programs.  All these people, organizations, institutions and corporations would then be expected to loudly and clearly demand that Congress raise the debt limit immediately.  If history is any guide, about the time these types of extraordinary actions become necessary, Congress will recognize they had once again waited until the last second to act, and they will agree to raise the debt ceiling for another year or two.  Once again, the crisis will be averted, but the problem will not be solved.

What happens if Congress can't come to an agreement, and things start to get ugly?  In theory, the President has a couple of options, both of which are fraught with risk.  First, under the 14th Amendment which prevents the government from legally defaulting on its debts, the President could simply declare the debt ceiling unconstitutional and order the Treasury to issue debt in spite of the law.  The problem is that the bond markets would see that as a different class of debt, bonds with a large asterisk next to them, and would likely insist on a higher rate of return for them.  And if, ultimately, the Supreme Court ruled against the President, what would happen to those bonds and their bondholders?  Second, there is a unique provision in US law for one particular type of currency.  Here we have Subsection (k) of 31 USC § 5112 "Denominations, Specifications, and Design of Coins":

(k) The Secretary may mint and issue platinum bullion coins and proof platinum coins in accordance with such specifications, designs, varieties, quantities, denominations, and inscriptions as the Secretary, in the Secretary’s discretion, may prescribe from time to time.
Under a literal reading of this section, the President could instruct the Treasury to mint a couple of trillion dollar platinum coins and place them on deposit with the Federal Reserve, which would serve as a replacement source of revenue.  The problem here is this would remove any pressure to raise the debt ceiling from Congress, and might, in the end, serve to permanently institutionalize the debt limit at the current level.  This would turn a gimmicky stopgap funding measure into the primary source of revenues to cover deficit spending, and would have unknown effects on the global economy.

At this point, we cannot know how it will all turn out.  We can safely assume that any solution will come down to the very last possible moment, and will likely be partial and temporary in nature.  In this case the President is faced with more than a political problem - the "weaponization" of the debt limit is far too dangerous to the American, and for that matter, the global economy to be allowed to continue to exist.  The President should not agree to ANYTHING in exchange for raising the ceiling - but he should consider nothing short of the elimination of the debt ceiling law entirely.