See you on the other side

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I rang some people at big banks this morning, who do the liquidity and balance sheet management, to see how they are preparing for the August 2 deadline for US debt funding.  They seems remarkably sanguine.  The feeling is that the President and the Congress will take the US close to edge, but not over it.  I am not so sure.  The positions of the two parties look very entrenched and hardline to me.  They are so far apart that one or both parties will have to back down to get a deal done, and that is unlikely.  My guess is that one of three things will lead to a resolution.  In order of likelihood they are:

1.  The parties go past the deadline (over the edge) and the Treasury suspends payment of Social Security checks and federal government wages and salaries, including military salaries.  The resultant public uproar then forces the parties to do a deal — probably a short term extension to the debt ceiling.

2.  A meltdown in the markets before August 2 forces the parties to do a deal — again most likely a short term extension.  A meltdown means a collapse in stock prices.  The dollar could collapse, but that won’t precipitate a panic by the US public — it might even be seen as a good thing.  US Treasury prices won’t collapse either, because despite everything US Treasury bills are still the risk free asset (to USD investors).

3.  A grand bargain is worked out.  A way out of the impasse is to take negotiations to a higher level.  Both parties give up a lot to get a lot, so both can be seen as winners.  Giving up a lot means: for Republicans big tax increases and for Democrats deep cuts to social security and medicare.

None of these scenarios leads to a default on US Treasury securities.  I think it is very, very unlikely that any coupon payments will be missed or that any bills won’t be fully paid out at maturity.  That really would be a disaster.  Security holders will be treated like they have a senior claim on the US Government and other claimants, such as Government employees and dependents will have their payments frozen.

Republican resolve in this matter should not be underestimated.  The Tea Party’s effect on the party has been dramatic.  It seems that no Republican member of Congress can afford to be seen to be soft on fiscal discipline.  Otherwise they will face a stiff challenge from a Tea Party candidate at the next primary for their seat.  Hats off to the Tea Party for bringing about that change, because regardless of the current crisis the US is heading for fiscal disaster unless it stops spending more than it taxes.

Another reason that the dispute will go to August 2 and perhaps beyond is that many Republicans are not convinced that passing the deadline will be that bad.  And, they may think that this crisis is an opportunity to fatally wound President Obama.  Think back to the impeachment and trial of President Clinton.  50 Republican Senators voted to remove an elected President from office for lying about consensual sex.  That was a gross subversion of the constitutional process. Impeachment and trial is reserved for high crimes of such as bribery or treason.  The impeachment and trial of President Clinton showed how crazy the Republicans can get.  They hated Clinton more than they loved America.  Don’t be surprised if Congressional Republicans get a bit crazy in this episode.  They think they have President Obama cornered.  He can’t agree to their demands, he can’t back down and if a crisis eventuates, then he will be blamed.

 

14 Responses to "See you on the other side"
  1. David  The buck stops with the President, there is no for him to avoid the blame for a crisis.  President Obama’s inability to escape blame is a bit ironic because as a candidate he was the outsider to decision making on the Iraq war.  He could say that Hilary Clinton and others voted for the war and he didn’t (he was not in the Senate at the time).  President Obama’s opponents in the upcoming election will be able to say that they would have handled things differently, without having to have had to made any real decisions on the budget crisis, in the same way that Obama did when he was a candidate.

  2. <blockquote> Hats off to the Tea Party for bringing about that change, because regardless of the current crisis the US is heading for fiscal disaster unless it stops spending more than it taxes.</blockquote>
     
    Yes, but they fail to distinguish between the long-run fiscal crisis and the idiocy of radical, immediate fiscal tightening in the middle of a very weak economy with very high unemployment.
    The preferred solution – spending cuts that would effectively gut the federal government – is also completely mad.   Infuriating as it must be to conservatives, the advanced economies of the world have conducted a natural experiment for the past 60-odd years and the evidence is clear-cut; governments run health care far more efficiently and effectively than private enterprise does.   As such, the notion that government should shrink, in an era where an aging population is going to continue to rightly demand more health care, is insane.

  3. Sam you might have a better feel for US public mood than I do (I haven’t spoken to anyone in the US recently) but basing on articles I’ve read (ala David Brooks ’The Mother of All No-Brainers’) I just got the impression people were blaming the GOP.

  4. Robert
    The Tea Party Republicans know that if they don’t get fiscal tightening now, then the chance is lost until 2017.   The President wants a large extension to the debt ceiling — enough to take him past re-election and then he will never have to worry about America’s fiscal crisis ever again.  We are seven days out from the deadline, why doesn’t the President take the offer of a short term fix — because he is holding out for a solution that takes him past re-election.  

  5. David 
    I think the politics are as follows.  Republican incumbents have to worry more about primaries, in which they will face the Tea Party if they waiver, than the next congressional election in which they face the Democrats.  The President does not face the Congressional Republicans in 2012, he will face a Republican candidate who is not currently in the Congress — Unless it is Michelle Bachmann who is a Tea Party leader.  None of the blame can accrue to Obama’s opponent in the next election — that is the sense in which he will shoulder the blame.  The President is in a corner on this.   

  6. Great Analysis Sam. I agree on all points. Tea party politics has created polarization in the US congress to a level that anyone taking a moderate position is either kicked out from primaries or they adopt a further right stand. John McCain is a good example. The market confidence on the ‘adults’ of congress seems misplaced. John Boehner doesn’t seem to agree to anything but a short term deal so that it can be a very sticky problem for Obama in 2012 elections. Sadly, they would want to play politics even if that means that it will send shock waves to the world economy.

  7. Sam, do you honestly think the long-run fiscal imbalance in the US economy is a worse problem than the unacceptably high levels of unemployment right now?  Aside from anything else, unemployment is a massive drag on the budget in its own right.
    And if the Tea Party Republicans really think the deficit is the worst problem the country faces, there’s an easy solution – do a deal with the Democrats that includes tax increases.  Indeed, at least some of the work can be by just letting the tax cuts passed under Bush expire.
    As such, their first priority is clearly to ensure that rich people don’t pay more tax.  Their subsidiary goal is to prevent Obama’s re-election in 2012, mainly to ensure the first goal is achieved.  
    As for deficits, the history of the GOP over the last few decades has shown that their concerns for deficits are only in evidence under Democratic presidents.  Fiscal rectitude is purely a tactic, a means to an end, not a real goal.
     

  8. Robert,
     
    The Tea Party cares about government spending, not government deficit.  They are looking to “starve the beast” as a way to force a reduction in spending.  So there is no logical inconsistency to their tactics (to that extent).

  9. “Hats off to the Tea Party for bringing about that change, because regardless of the current crisis the US is heading for fiscal disaster unless it stops spending more than it taxes.”
    And indeed I do give my hats off to the Tea Party for this. However some tax increases are clearly need in the short term.

  10. I don’t favour a large state, but I agree that some tax increases are in order in the US.  First, President Obama should have allowed the Bush tax increases to lapse in 2011 under their 10 sunset clause (a clause that the John McCain insisted on).  Why President Obama allowed those tax increases to go on is a mystery to me. Second, corporate tax rules needed to be tightened up.  Third, the tax deductibility of mortgage interest should be eliminated (after house prices stop falling).   

  11. Several points.
    1) US tax rates are very biased.  They have very low marginal rates for the super rich.  Very low marginal rates for dividends and capital gains.  Basically the entire tax code has been manipulated by the richest 1% to screw everyone else.  The art has been to convince regular voters that this is ok.
    2) There are very few places that massive spending cuts are possible. 
    Defense -can’t be seen to be soft on security
    Health care – can’t cap spending because that is death panels
    Social security – can’t cut the benefits of wealthy retirees who have millions in assets because they contributed their taxes and their “owed it”.

    That’s about 75-80% of the federal budget across three almost untouchable sectors.

    3) Tea party seems to be a populist front for the super rich.  I still don’t quite see how you can get low income (under $250K a year) to violently oppose tax increases on people who earn over $1M a year.

  12. I think the US lost its way abround the time that Kennedy was assasinated. It’s all been about unbounded individual greed since then. There seems to be no sense of community responsibility on the part of the rich to do their bit anymore. And the rich have managed to screw the poor for decades as US writer and journalist Chris Hedges keeps pointing out. Try searching Google for: Chris Hedges ‘Empire of Illusion’ videos.

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