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Contemptible Advocates of Debt Default

21 Jun 2010
Posted by Bruce Bartlett
Historian Jeffrey Rogers Hummel accuses me of being “awfully contemptuous of those opposed to increasing the federal debt limit.” He is right. I am contemptuous of those who know so little about the federal budget that they actually believe the debt limit is an effective tool for controlling growth of the federal debt.
 
I went into detail on this subject some years ago in testimony before the Senate Finance Committee, where I explained the history of the debt limit and why it is totally ineffective at controlling growth of the debt. The curious can find it among the committee’s printed hearings. The date was February 14, 2002. On that occasion I proposed abolition of the debt limit to deafening silence from the committee, but nodding agreement from the Treasury secretary.
 
One doesn’t really need to read my testimony, however, because it is perfectly obvious from the most casual examination of the record that the debt limit has never exercised any constraint on spending or borrowing. The debt limit has always been increased, the debt has risen almost continuously, and no administration or Congress has ever once, even for the briefest moment, questioned the wisdom of a single spending increase or tax cut because of the debt limit. (Note: the debt limit only came into existence during World War I; before that Congress had to approve every Treasury bond sale and their specific terms.)
 
Opposing a debt limit increase is simply an example of political posturing at its worst—Dan Shaviro calls it “almost criminally negligent.” It allows members of Congress who voted for massive tax cuts and new spending programs that they knew would increase the deficit to pretend that they are fiscally responsible by voting against a debt limit increase once every year or so. And the offenders belong equally to both parties. Among them was then Senator Barack Obama of Illinois, who voted against a debt limit increase back in 2006. Don Marron calls the vote to raise the debt limit a tax on the majority party.
 
And it allows bloggers who imagine themselves to be Horatio at the Bridge, fighting against the evils of government debt, to sound as if they are proposing something meaningful to reduce deficits without naming specific spending cuts or tax increases that would reduce the deficit or finding the political support to get them enacted. Such people are too pure and too principled to bother with the political process. They prefer to lob ideological grenades on obscure web sites and pat themselves on the back for their courage while ripping those that care enough about the deficit to suggest that raising revenues might just possibly be part of the solution.
 
The problem I warned about in a recent column is that this political posturing is not costless. What happens when the debt limit is reached is that the Treasury loses the legal authority to borrow. But interest payments on the debt must be made every day to those who bought Treasury bonds, bills and notes in good faith, believing that they were the safest investment they could make. (Safe in the sense of having no default risk.) And Treasury securities mature each day and must be paid off.
 
Much of the cash that the Treasury raises on a regular basis goes to pay that interest and pay off investors in Treasury securities. These include pension funds, insurance companies, individual investors who depend on interest income to live and pay their bills, as well as many others. Thus if the Treasury cannot borrow it must necessarily go into default as any borrower does when he fails to make a timely interest payment or redeem a security that has matured.
 
However, the Treasury still has cash flow from taxes and other payments. By law, bondholders have first claim on that cash flow in the event of default. They would also have the right to go to court and seize property belonging to the government to satisfy their claims.
 
If Treasury must pay bondholders first then others depending on federal payments, such as those on Social Security, would have to wait until it had sufficient cash flow to cover those payments. Does Hummel think that the chaos and pain caused by such a disruption of the national finances will lead to a libertarian paradise? I think not. People aren’t going to suddenly demand that spending be slashed, as he supposes. More than likely they will take it out on the dimwits in Congress who voted against the debt limit increase.
 
I think those who are genuinely concerned about the debt to the point of advocating irresponsible policies such as defaulting on the debt simply don’t understand that the sort of debt crisis the United States would face in the event of congressional failure to raise the debt limit is quite different from the sort of debt defaults that Reinhart and Rogoff detail so well. Those involved markets imposing discipline by refusing to buy securities from governments that were not perceived to be good credit risks because of excessive spending, insufficient tax revenue, a weak currency, poor political leadership or whatever.
 
A U.S. default resulting from failure to raise the debt limit would be of an entirely different character. It would not result because the market has no appetite for Treasury securities—the very low level of interest rates on such securities is proof that market demand is strong—but for a technical legal reason that is only possible in the U.S. To my knowledge, no other nation on Earth places a legal limit on the amount of debt its national government can issue. Other countries correctly recognize that deficits are simply a residual resulting from decisions that the legislature has made about how much to tax and spend. It is silly to treat the debt as an variable that is subject to control without raising taxes—something people like Hummel seem to forget is the most viable option in the event that deficits need to be cut quickly—or cutting spending only on a small slice of the federal budget, so-called discretionary programs.
 
To conclude, yes I am indeed contemptuous of those who advocate irresponsible policies in a juvenile belief that they are standing for principle instead of simply displaying their ignorance and immaturity. Sadly, we no longer live in a society where such people can safely be ignored. Some of them have an hour each day on Fox News to spew their nonsense or talk radio programs with large audiences or are members of Congress. Therefore, it is not unreasonable to think that in about 10 months they may have sufficient support to cause a default on the debt. When that happens we will see whether it leads to a downsizing of government or total chaos that nothing good will come from. I’m betting on the latter.
 
Addendum
 
Unrelated to my post, Felix Salmon discusses the same issue. He is somewhat blase, feeling that the Treasury has more wiggle room than I think it has, that Congress is more responsible than I think it is, and markets less nervous than I think they are. I fear a replay of Greece, only 100 times worse. Salmon thinks it will be more like Freddie and Fannie's default--a non-event because it was so widely anticipated and discounted by the time it actually happened. I think that markets are so certain that a default on Treasuries is impossible that they will be shocked beyond belief if it happens. Early next year we are going to get a test of these competing views, I think.

Article 1, Section 8 of Constitution

The Constitution says that Congress shall have power "To borrow money on the credit of the United States." Maybe other countries don't have that provision in their constitutions, but Congress cannot abdicate that power without an amendment to the Constitution. It cannot simply say to the Treasury, "Go ahead and borrow whatever you need whenever you need it."

Your recommendation to scrap the debt limit would apparently require Congress to take multiple votes throughout a session subject to grandstanding and posturing instead of just one vote every few years.

BTW, the reason the debt limit is ineffective at stopping deficit spending is because it's stupid to ask Congress to discipline itself. If the resetting of the debt limit were put beyond the reach of Congress, then it could force Congress to raise taxes and cut spending to reduce borrowing.


A more interesting question

is how the courts would adjudicate this provision of the 14th amendment in the event of a default:

Section. 4. The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned. But neither the United States nor any State shall assume or pay any debt or obligation incurred in aid of insurrection or rebellion against the United States, or any claim for the loss or emancipation of any slave; but all such debts, obligations and claims shall be held illegal and void.


Except...

That if "resetting of the debt limit were put beyond the reach of Congress" then it would fall prey to your own argument - it would be removing a right Section 8 gives them and thus unconstitutional. To take it away would be similar to them giving up their power to declare war...

Oh, wait...

Seriously, that sentence is at odds with your thesis. If the "debt limit" were beyond the reach of Congress then the need for their approval could also be put beyond Congress.


Constitutional Amendment Required

Scathew:
A constitutional amendment would be required to put the debt limit beyond the reach of Congress. That is the point I'm making. My own suggestion is to institute a Debt Limit Referendum ( www.thepeoplesdebt.com ) as one way to put the ultimate power of raising the public debt limit (excluding trust fund accounts) beyond the reach of Congress. It would force Congress to make the case to the voters why the public debt limit should be increased. Instead of engaging in the Kabuki dance where the minority party gets to torment the majority party, better to make the public debt limit a serious public matter that get direct attention.

I cannot imagine a better way to force the electorate to show concern for the incongruence between our taxation and expenditure policies. I also cannot imagine the electorate not approving a reasonable request for increasing the public debt limit IF the proponents accompany the request with a budget plan with targets that pledge gradual reductions in deficit spending.


National referendums

are a dumb idea. Do we really want the whole country to be like California? No way. Forget it.


Don't confuse initiatives with referenda

Bruce,

California voters can enact legislation at the ballot box with an initiative. However that is not a referendum.

A referendum is a check upon the power of the Legislature. The Congress (or Legislature) proposes an increase in the debt limit, but the increase does not take effect until it receives majority vote approval (or majority of electoral votes at the federal level). Such a regime would be imminently more sensible than a balanced budget requirement that has far more problems which you've enumerated on several occasions.

Our Founding Fathers lived in a world with a gold standard where the US Dollar was not a reserve currency. In that world, Congress could never engage in the deficit spending witnessed today. Our constitution needs to adapt to a world where Congress is unable to discipline itself. Other than screaming at dumb Conservatives, I haven't seen any better ideas.


What Californians do at the

What Californians do at the polls is indeed to legislate through referendum. YOu make a distinction where none exists. Beyond that, it is not the job of Congress to discipline itself. It is the job of the electorate to do so. That's why all bills concerning taxation must originate in the House, where members are up for election every two years.


Refer to a Dictionary, please

Fan of Common Sense,

There is indeed a huge distinction between referenda and initiatives. In Europe, several nations held referenda regarding EU membership. That's not the same as the electorate placing a piece of legislation on the ballot outside of the regular legislative process and enacting a law, as is done in California. Initiatives (and Propositions) are the source of negative perceptions of California law-making. I cannot remember that last time the state had a referendum on the ballot.

The topics decided and initiative for consideration of a referendum is controlled by the Legislature. That is the difference between what you imagine is done in California and what I'm proposing.


Well put...

Incidentally, the OP is well thought out and well enumerated.


My assumption is

that any technical default would be of short duration. But maybe not. At this point I fear that Republicans are just crazy enough not to give a damn. In that case, we will inevitably have litigation of issues that have never in our history been litigated. What the courts will do in the event of a prolonged failure to raise the debt limit is an interesting question. If anyone knows of any law review articles on this topic please post references.


Avoid default by Fed lending directly to Treasury

Bruce,

Before a default would ever occur, I suspect that Congress would remove the obstacle currently in place that only permits the Federal Reserve to purchase Treasury securities on the secondary market.

To avoid the Article 1, Section 8 problem, Congress could create a new class of debt that is not classified as "borrowing money on the credit of the United States." It would be debt that the Fed could purchase directly from the Treasury, essentially printing money without having to book a real Treasury security on the asset side of the Fed's ledger.

I imagine that Congress will get very creative if doomsday really got that close. Republicans would probably prefer that solution to cutting Social Security checks and/or boosting income tax rates.


If Congress could do that

it wouldn't need to raise the debt limit. It's not a solution to the problem unless it's something that Treasury and perhaps the Fed can do on their own authority under current law. I've been think about some sort of repo deal that might get around current constraints. The Fed sells back to Treasury some securities that will technically reduce the volume of outstanding securities, which Treasury can resell to raise cash, and in return the Fed gets a promise to pay at some date in the future. It's a type of debt that might slide under the legal radar at least long enough to get past a financial crisis.


Tax Receivables Financing

A clean way to avoid Article 1, Section 8 restrictions on issuance of debt is to allow the Federal Reserve to purchase Tax Receivables (TRs) from the Treasury. This is analogous to Accounts Receivable (A/R) financing offered by some banks and non-bank finance institions for working capital financing. Instead of lending money to a company, the institution pays a discount on the value of the company's A/Rs, and actually purchases the asset and often handles the collection directly from the company's customers. It's the sort of thing Sharia-compliant bankers do a lot of to technically claim they're not charging interest on a loan, when the economic effect is the same.

The Fed could do the same. It could "purchase" $500 Billion of 2032 Tax Receivables by crediting the Treasury Fed Account. It increases the money supply to facilitate deficit spending. From a money supply perspective, it's equivalent to an open market operation that purchases $500 billion of Treasuries.

22 years from now when the revenue comes in, the Fed can lower the money supply by $500 billion.

Congress would have to enact legislation to permit this, but it is a way out of the doomsday scenario of US Debt Default that is consistent with Article 1, Section 8.


Bruce, your position seems to

Bruce, your position seems to be that not raising the limit would have no impact at all, and that it would be a disaster.
I don't really have an opinion on whether this would be the best way to deal with the situation, but isn't the idea that by making the consequences near-term and clear of not dealing with the deficits, legislators would actually deal with them sooner rather than later?


Making hard choices

The desire to limit the debt is to force short-term politicians to make long-term choices rather than punt the burden to subsequent generations. The debt limit may not work, but I would be interested in Bruce's thoughts on what would.


Look, it you think the

Look, it you think the federal government is spending too much money, propose and pass concrete cuts in spending. Don't muck around with the debt limit in the hopes that all the hard choices can be avoided, and all the blame for cutting popular programs can be shuffled off to someone else.


Then what are Constitutions for?

OK, politicians should be making the hard choices to cut spending. But they haven't. We are blessed and cursed by the US Dollar's status as a world reserve currency. The curse is that politicians can make smart decisions for short-run political profit maximization by adopting deficit spending policies that are a bane for long-term financial health.

This is exactly the kind of situation that calls for Constitutional Restraints. Balanced Budget amendments are unworkable. Spending limit amendments are not bi-partisan, too inflexible, or too ridled with escape clauses to be workable. I believe that a Debt Limit Referendum is the best way to solve this problem.

Republicans at the state level do support tax increases and spending cuts while the Republicans at the federal level do not. I think the main difference is the lack of a Federal Reserve monetizing state government debt. We need to add some kind of a restraint on the untrammeled issue of public debt to force hard fiscal choices to be made by both parties, especially the Republicans.


Growing Public Debt is more than impractical,

Exclamation point! Referendums are impractical.... compared to what?

Judicial review is impractical. Bicameral legislatures are impractical. Financing political campaigns is impractical. Democracy is very impractical.

Unrestrained deficit spending with a growing public debt is going to be very constraining -- someday. Hectoring irresponsible politicians hasn't worked for a long time. It's time for something more than hectoring.

Maybe it's just some anti-California impulse I'm feeling from the audience, but I don't understand the downside of a debt limit referendum. It's possible that Congress could propose an increase in the debt limit, and the electorate could revoke it. It's possible the party out of power could launch a scorched earth electoral campaign to say "don't increase the debt limit" and hope that they would never have to answer to the electorate about how they'd propose to balance the budget to avoid additional borrowing.

The more likely scenario is that both parties would have to develop coherent budget programs (like the Conservatives in the UK have done) that would raise taxes (Dems more, Reps less) and cut spending (Dems less, Reps more). There would be bi-partisan support for an increase in the debt limit, but differing visions about the policy mix to stay on track to meet the target. The debt limit Kabuki dances in Congress would be history.

My guess is that the debt limit increase offered to the electorate would be tailored to last for 4 years. Get too greedy, and the electorate would vote it down. But for the first time you'd force both political parties to run on a mathematically sensible budget platform. I think that the electorate would respect that kind of honesty. But they won't hear it until the constitution is rigged to force the electorate to punish politicians who don't offer coherent budget plans. Or until we reach financial Armageddon.




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