Is President Obama and his administration acting in a highly irresponsible manner in the current debt crisis in the US? At 8.30 am on Thursday 10 October we may get an answer to that question. At that time Jack Lew, the US Treasury Secretary, will begin testifying before the Senate Finance Committee. Secretary Lew will certainly be asked about the options that the US Treasury has to avoid a default on US Federal debt if the debt ceiling is not raised before the Treasury runs out of cash sometime after 22 October (the ‘X’ date).
If Jacob Lew is honest and frank in his testimony then he will say something along these lines. There are at least three feasible measures that the Treasury can take to avoid a sovereign default by the US.
1. The Treasury can prioritise payments to use incoming cash from income and payroll tax payments to pay interest on Government debt first, before other payments to medicare, social security, etc. are made. There are certainly large technical challenges to prioritisation of payments, but the system used to make payments on Government debt is separate to the other systems and prioritisation should be possible. (If prioritisation is no possible, then Secretary Lew needs to explain very clearly why not. Treasury officials have said that prioritisation is not feasible but have not been precise in stating why not. It is not enough to say that “the systems are complex”.)
2. The Treasury could mint large denomination coins and deposit them with the Federal Reserve and then make payments from that positive balance at the Federal Reserve. There is no impediment to this. The Treasury Act clearly gives the Treasury the power to mint coins of any denomination. (This power was intended to be used to mint commemorative coins, but nonetheless, the power to mint coins of any denomination resides with the Treasury Secretary. Moreover, those coins are legal tender and therefore the Federal Reserve must accept them. The coins do not count towards the debt ceiling.)
3. The Treasury could issue super premium bonds. That means that it could replace maturing debt with debt that has a very high coupon — say 20% — that will then sell at a large premium to its face value. Only the face value counts toward the debt ceiling. A bond with a face value of $100 might sell for $300 if the coupon rate is high enough. So if the Treasury issues a $100 bond with a very large coupon then it could use the $100 to repay the principal on the maturing bond and the other $200 to pay off other liabilities.
If Jacob Lew testifies that these measures are not feasible and that a default cannot be avoided if the ‘X’ date of 22 October (or later) is passed, then he will be acting in a basely political and highly irresponsible manner. Since he serves as the appointee of President Obama, then by implication President Obama will be acting in a highly irresponsible way.
President Obama could have already made it clear that there are feasible measures for preventing a default. Those measures are highly unorthodox and would certainly only be used in an emergency, but nonetheless they are credible measures for preventing default if the X date is passed. That is, President Obama could have already stated that no matter what the US is not going to default. In the face of intransigence by House Republicans, a statement by the President that no default will be allowed to happen no matter what the Republicans do is what is needed to reduce uncertainty.
If there is no resolution to this crisis in the next few days, then the uncertainty about what will happen after the X date will quickly erode the confidence of the financial markets and consumers and companies. That uncertainty can do long-lasting damage to the real economy.
The President could eliminate that uncertainty today, but he has chosen not to for political reasons. He wants rising fear to force the House Republicans to back down. But if House Republicans do not back down and the President does not clarify what measures will be taken to prevent default then with every passing day substantial and long-lasting damage will be done to the real economy. Both parties will be to blame for their reckless and basely political behaviour.
President Obama has said that Jacob Lew will explain the Treasury thinking on the management of the crisis when he testifies — we will see.