Debt Ceiling Chicken
A Look at What is Really Going On
We’re all familiar with the Game of Chicken—typically in the form of two cars heading toward each other on a collision course until one car swerves to avert mutually assured destruction. The swerving driver is considered “the chicken.” This game is normally played by immature male drivers, but we now play it in Congress under the guise of raising the U.S. debt ceiling
Once again, Democrats and Republicans are hurtling toward each other on a collision course. Despite, having known about the deadline—now thought to be around June 1—for many months, there remain a few scant weeks to make a decision on how to avoid a catastrophe. The contention over raising the debt ceiling is portrayed in the mainstream news as either a ho-hum political game or an impending economic catastrophe. So should you really care?
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Although talking about the “debt ceiling” sounds pretty boring, I’m going to have to say “yes,” because even talking about not raising the debt ceiling has consequences for your wallet and the downside risk is huge.
Just Threatening to Not Raise the Debt Ceiling Matters
History has shown that as the prospect of an unprecedented U.S. default goes up, consumer confidence and the stock market go down. The best guide we have for this is what happened in the 2011 debt crisis debate, which resulted in Standard and Poor’s downgrading the United States’ credit rating. A U.S. Treasury report, The Potential Impact of Debt Ceiling Brinkmanship, nicely explores the effects on several markets leading up to the date a decision was reached on August 3, 2011, and afterward.
In the graphs below, you can clearly see the decline in consumer confidence, small business confidence, and the overall stock market (represented by the S&P 500). This occurred for months leading up to the decision point—while talks were going on—and then you can see the months-long recovery afterward. Similarly, after the credit rating downgrade, you can see market volatility (VIX) went sharply up, as did interest rates on corporate bonds and mortgages.
So far in 2023, none of these indicators seem to have reacted like they did in 2011. But if the talks don’t start looking promising soon, it could happen, and the point is that once it does, it doesn’t necessarily recover soon.
The fact that the markets don’t seem to be paying much attention at the moment could be considered a measure of confidence that an agreement will be reached. However, there is one area of the market that just recently started reacting, and now credit default swaps (CDS) recently reached an all-time high. The rising market for these instruments can be taken as an indicator of the increasing threat of default, although the indicated risk is still fairly low.
As of last week, the spread on one-year CDS implied a 3.9% probability that the U.S. would default, according to MSCI Research analysts. That was lower than the probability during the 2011 debt ceiling crisis, when a protracted legislative standoff prompted Standard & Poor's to downgrade the U.S. credit rating for the first time.
The Potential Consequences
Why do we care about the debt ceiling? What is it? No other country has one, so let’s take a look at what it really is.
The debt ceiling was established by the Second Liberty Bond Act of 1917 which was passed to provide more flexibility for U.S. financing in World War I. This Act established a limit on the total amount of new government bonds that could be issued, and this limit became known as the “debt ceiling.” Currently, this debt ceiling applies to almost all federal debt.
The U.S. Treasury defines this debt limit as follows:
The debt limit is the total amount of money that the United States government is authorized to borrow to meet its existing legal obligations, including Social Security and Medicare benefits, military salaries, interest on the national debt, tax refunds, and other payments.
If this limit is not increased, the U.S. will not be able to pay its bills. Thus, according to the U.S. Treasury :
Failing to increase the debt limit would have catastrophic economic consequences. It would cause the government to default on its legal obligations – an unprecedented event in American history. That would precipitate another financial crisis and threaten the jobs and savings of everyday Americans – putting the United States right back in a deep economic hole, just as the country is recovering from the recent recession.
And CNN estimates the effects as follows:
A lengthy default would wipe out about 8.3 million jobs and bring unemployment 5 percentage points higher, economists at the White House said last week. Even under a shorter default, the economy would suffer the loss of about half a million jobs and the unemployment rate would rise by 0.3 percentage points, they said.
So you have to ask yourself, “How would allowing a debt default to happen would be fiscally responsible?” (Answer: It would not be.)
A Paying Limit, Not a Spending Limit
Since 1917, the debt ceiling has been raised about 100 times. Until recently, it was a mundane bipartisan affair, because everyone realized it needed to be done. But, in 1995, the Congress led by Newt Gingrich started using the debt ceiling as a cudgel to secure commitments to future spending cuts.
The GOP story since then has been that we need to cap spending like you would if your teenager spent too much on your credit card. On the surface, you can understand the concern, because the U.S. debt is getting quite high, as shown in the charts below.
Because it’s such a long timeframe, I needed two charts, so here are the more recent years from USAFacts,
You can see that there has been a steep increase in the national debt, and this has understandably caused alarm to some citizens, as it should.
House Speaker Kevin McCarthy explained the GOP position as follows:
“Let’s sit down together. Let’s look at the places that we can change our behavior…Why would we sit back and be so arrogant to say, ‘No, there’s no waste in government?’”
McCarthy’s statements seem reasonable on the surface, but the issue at hand is not whether to discuss a cut or cap government spending—it’s whether hijacking a routine vote about raising the debt ceiling is the appropriate and responsible place to have that conversation.
The opportunity arises because of confusion over the purpose of the debt ceiling. That is, the debt limit is not a cap on spending—it’s a cap on paying for what is already spent. As the U.S. Treasury states,
The debt limit does not authorize new spending commitments. It simply allows the government to finance existing legal obligations that Congresses and presidents of both parties have made in the past.
Authorization of government spending is done through a different decision-making process conducted at another time. That process is called the Appropriations process, and it includes Republicans.
So to compare the debt ceiling with a credit card limit is misstating the issue. Raising the debt limit enables you to pay your credit bill, not limit what your teenager charged on it.
Why Is This Happening?
On the surface, the GOP messaging is about reigning in out-of-control spending. But, after reviewing the results of the many debt-ceiling fights during the past couple of decades, it is unclear if haggling over the debt ceiling has produced any real impact on government spending or the debt. However, as discussed earlier, it has clearly caused disruption in financial markets, leading to increased pain for citizens.
So what’s going on here? If linking the cuts to raising the debt ceiling is a good idea, why is the haggling only done by Republicans when there is a Democratic President? Why are we willing to flirt with potential economic catastrophe over this?
While at times it is quite tempting to declare all politicians are idiots, we really need to assume they are rational actors pursuing their own goals. And what might those goals be? Clearly, to stay elected by scoring the most political points that they can.
And how do politicians score political points? By seeming to appease their constituents and damaging the reputations of competing politicians. Recent polls illustrate the issue, suggesting how the debt ceiling debate makes sense to the GOP.
Overall, Republican voters will blame Biden for a debt default. Of course, Democrats will blame the Republicans. So, if there GOP causes a default their voters will not blame them, although current polls show independent voters might allocate a slightly bigger share of the blame to them.
Substantially more people (58%) think the spending cuts should be handled separately than the debt ceiling. A mere 26%, take the GOP view that Congress should let government pay its debts only if the administration agrees to spending cuts. That includes 46% of Republican voters.
However, the group that favors defaulting if spending cuts are not included in the agreement to raise the debt limit is heavily dominated by very conservative voters. This is a very important voting block for Republicans.
So here we get to the evidenced-based view of what is really going on: The GOP is manufacturing a debt ceiling crisis to a) continue their appeal to extremely conservative voters, and b) do some damage to President Biden’s re-election chances.
Columnist Ed Kilgore explains it this way:
What if McCarthy or the Freedom Caucus or some other strategically positioned group of Republicans is convinced that disaster for the economy and the country could produce an electoral victory for the GOP? If so, that would destroy any incentives for compromise: Republicans will either win important concessions from Joe Biden and his Democrats that would gratify potentially rebellious MAGA types or they’ll inherit a damaged country in November 2024 amid the sort of radically diminished expectations that ease the burden of governing
And, drawing from the fact that then-President Barack Obama took a significant hit in his popularity from the 2011 debt ceiling crisis, Mr. Kilgore adds,
Barack Obama managed to claw back much of his popularity and was reelected in 2012, but it was a near thing. Republicans may calculate that an actual debt default, likely followed by a recession, would doom any incumbent president, particularly if voters are inclined to blame that president at least partly for a debt default triggered by the other party.
Then again, the 2011 debt ceiling crisis did damage support for Republicans in the House.
Politically, the crisis caused support for the Republican Party to drop, whose support for the debt-ceiling deal was needed as it controlled the House. The party saw its approval ratings drop from 41 percent in July to 33 percent
So the crux of the issue seems to hinge on the GOP evaluating how much they might be blamed by the overall electorate versus appeasing the critical MAGA elements and how much President Biden’s re-election chances would be hurt. Of course, a bad economy also hurts the incumbent President’s chances for re-election. But, would they go so far as to cause a recession on purpose?
It’s hard to say which way their calculations would fall, although Robert Reich, a former US secretary of labor and professor of public policy at the University of California, Berkeley, argued that it is all political theater and that the debt ceiling ultimately will get passed. He claimed that the Biden administration will counter with proposals to hike taxes on the super-rich, and little will change. He said,
But here’s the dirty little secret. Neither of these two theatrical productions – neither the Republicans’ refusal to raise the debt ceiling nor Biden’s big tax hike on the super-rich – will ever happen. They’re both fantasies.
A default on the nation’s obligations would bring on an economic calamity that Republicans don’t want to be responsible for. And a giant tax increase on the super-rich would be a miracle, given their political clout.
These two productions are being staged for the public – two competing performances, each intended to score political points against the other.
What Can You Do?
Probably the debt ceiling will get raised. While some commentators might muse that the GOP could do more damage to Biden by causing a default, the outcome would be highly unpredictable and dangerous. It could easily backfire and cause the GOP members of Congress to lose their seats.
Conversely, arguing about the debt ceiling for as long as possible may enable them to damage Biden’s popularity while building support with their core constituency. By watching the polls they can monitor how it is affecting their approval rating and adjust course as needed.
In the end, the real answer is probably to abolish the debt ceiling altogether. It’s a rule that has passed its time and is now being sub-optimized for political interests.
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