Contemptible Advocates of Debt Default
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.
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.