Congress again pushing US toward brink of financial calamity
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Mixed messages from Treasury Secretary Steve Mnuchin, pushback from members of the president’s cabinet and Republicans in Congress have added to brinkmanship by Democrats to up the ante on another epic showdown over the debt ceiling. Extraordinary measures by the Treasury Department are already being used to extend the deadline into September, but Secretary Mnuchin has been frustratingly vague about when we actually face default.  

The standoff poses a real risk that we could once again find ourselves on the verge of a U.S. Treasury default. The showdown in 2011 unnerved financial markets and resulted in the first downgrade in our country’s credit in August 2011. Economic growth slowed to a standstill as uncertainty spiked. We ended up with across-the-board budget cuts, which eliminated fiscal stimulus at a critical time in the recovery. That shifted more of the burden of supporting the economy onto the Federal Reserve, which has few tools. 

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Worse yet, those contractionary moves did nothing to rein in ballooning deficits over the medium term, which was the stated goal. The cuts did not address the elephant in the room: spending on Social Security, Medicare and Medicaid benefits, which are already rising at a faster pace as baby boomers age into retirement.

 

The irony is that the debt ceiling was initially designed to facilitate rather than constrain the Treasury’s flexibility to issue debt. Congress gave President Woodrow Wilson the ability to issue bonds as needed to fund World War I. Though the debt ceiling has undergone many iterations, it remains critical to Treasury’s financing government commitments that have already been approved. It does not include new spending initiatives; thus, holding the debt ceiling hostage does nothing to align spending with revenues. 

Failing to raise the debt ceiling would force the Treasury to stop making interest payments on our debt, including all bonds and bills. That would mean breaking the contract with all holders of U.S. Treasuries, which would be akin to a large number of Americans defaulting on all of their debt obligations simultaneously. It would make the mortgage defaults during the housing crisis look small in comparison.

Interest rates would spike as the world would lose faith in the U.S. as a safe haven. The value of the dollar would plummet. Government spending would contract, threatening retirees dependent on Social Security. A financial crisis would erupt and push the U.S. economy into recession or worse, a protracted depression. 

The downside risks from a failure to lift the debt ceiling actually embolden politicians to grandstand and take the debt ceiling vote hostage. It is a way for extremists in both parties to push their agendas, particularly during the height of 2018 budget negotiations, regardless of the risks. 

Making matters worse, the administration has voiced some support for obstructionist tactics and a government shutdown. Treasury Secretary Mnuchin recently waffled on his position by suggesting there is such a thing as a “good shutdown.” White House Budget Director Mick Mulvaney, who helped lead the charge to hold the debt ceiling hostage in 2011, has voiced a similar view

So far, investors have turned a deaf ear to this noise from Washington. It's hard to blame them given how many times this game has been played. If and when we reach the edge of the cliff, markets will react. That scenario would underscore the low probability of achieving a pro-growth agenda, which would represent another wake-up call to investors.

What could bridge an impasse over the debt ceiling? I find myself longing for an evening like last November when a rain delay allowed the Cubs to hit the reset button, pull together as a team and win the World Series. I guess it is asking too much for politicians to act as a team when they are  looking for their next election victory.

Their focus is so short-term that they can't agree within each party, let alone across party lines. That won't stop me wishing for another miracle of politicians putting the economy first for a change. 

Diane Swonk is the founder and CEO of DS Economics, an economic consulting firm. Prior to that, she spent more than 30 years in the financial services industry. As a well-known macroeconomist, she advises the Federal Reserve Board and its regional banks. She also served two terms on the economic advisory board to the Congressional Budget Office. She has been named a fellow by the National Association for Business Economics (NABE) for outstanding contributions to the field. Follow her on Twitter @DianeSwonk.


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