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Tick, tick. August 2nd is the Debt Limit Armageddon. Or Not.

 
 
Reply Tue 28 Jun, 2011 04:23 pm
It has been all over the media that the Dems and Repubs are at loggerheads over raising our debt ceiling. If that doesn't happen, the country will default on its obligations and the economy of the U.S. and the world will collapse. We have talked about this for some time on A2K in various threads. I thought I would try to consolidate the discussion.
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Type: Discussion • Score: 26 • Views: 52,968 • Replies: 1,354

 
Cycloptichorn
 
  1  
Reply Tue 28 Jun, 2011 04:32 pm
@realjohnboy,
Any opinion on the matter at all?

Cycloptichorn
Cycloptichorn
 
  1  
Reply Tue 28 Jun, 2011 04:37 pm
Quote:
America's debt ceiling
Special topics in calamity economics

Jun 27th 2011, 15:24 by R.A. | WASHINGTON

OVER the past week, there has been an uptick in fretting over the outcome of the debt-ceiling negotiations. House Republican Eric Cantor bailed on the negotiations, and a spate of public sniping broke out, generating fears that Republicans and Democrats are farther from an agreement than had been imagined. Bargaining has now been kicked upstairs to the president, who will meet with Senate leaders to try and hash out a deal.

In the current issue of The Economist, there is a rather disheartening look at just what might happen if talks fail. The distressing answer is that no one really knows, but that financial market havoc is almost sure to result. In a May post here at Free exchange, a colleague wrote that in the event of a temporary breach of the limit, the government would likely opt for immediate, massive cuts in order to prevent an outright default. Quite apart from the financial market implications, that would represent a hugely contractionary force on the economy, probably sufficient to send it back into recession. And in the case of actual default? Keep in mind that investors around the world have gobbled up American debt in recent years as a safeguard against trouble elsewhere. If that rock of safety suddenly became vulnerable, well, September of 2008 would probably look like a picnic in comparison.

My operating assumption has long been that the debt ceiling will be raised. The potential cost of a failure to do so is just too large for either party to tolerate. And despite the recent ructions, I still think that an increase in the ceiling is likely. But I think it's fair to say that the odds of some kind of "default", while quite low, have risen a bit.

This could potentially be a problem. Markets try to prepare for trouble. If there's a chance of bad times ahead, market participants will take precautions, just in case. They may move money to safer assets, increase cash holdings, curtail marginal investments, put off hiring, and so on. Do you see the problem? These sensible measures are themselves bad for the economy. Now, the probability of an actual default isn't very high. But the cost of default is catastrophic. So even if the odds of default shift from very small to slightly less small—from say 2% to 5%—that shift represents a substantial increase in the potential economic downside looking forward. And that, in turn, could lead to greater precautionary measures from banks, businesses, and households.

Because failure to raise the debt ceiling would be so nasty, that very possibility could cause serious economic damage even if the odds of an actual default never approach 50%. This, once again, is why Congress should tread extremely cautiously. Its only responsible course of action is to pass an increase in the debt ceiling without any further delay, and certainly without any further dramatics.


http://www.economist.com/blogs/freeexchange/2011/06/americas-debt-ceiling

Cycloptichorn
0 Replies
 
JPB
 
  1  
Reply Tue 28 Jun, 2011 04:44 pm
@realjohnboy,
realjohnboy wrote:

It has been all over the media that the Dems and Repubs are at loggerheads over raising our debt ceiling. If that doesn't happen, the country will default on its obligations and the economy of the U.S. and the world will collapse. We have talked about this for some time on A2K in various threads. I thought I would try to consolidate the discussion.


If Geithner has any balls at all he'll pay our debt obligations and shut down payment to the Congress and all federal public employees, including the on-shore military. I doubt he's got the cojones.
0 Replies
 
edgarblythe
 
  1  
Reply Tue 28 Jun, 2011 04:45 pm
I sort of expect Obama to twist Democrats' arms to compromise, while giving in essentially to the Republicans.
0 Replies
 
realjohnboy
 
  1  
Reply Tue 28 Jun, 2011 04:49 pm
@realjohnboy,
I thought I would try to set this up in a Q&A format to get this going. If a question interests you, please so indicate and someone here might expand on it. Or add your own!
1) Is August 2nd a drop dead date?
A) Probably not. The gov't can shuffle things around for awhile.
2) What happens if the gov't hits the debt ceiling?
A) In theory the government won't be able to issue new debt. It will have to ration cash on hand. It may have to decide to pay interest on debt and not pay social security benefits. Most if not all of that is fear mongering hype.
3) But the world's faith in the U.S. economy will be harmed?
A) I think that is correct, but more because of perceived political ineptitude than underlying economic concerns.
4) What is the difference between national debt and national deficit?
A) (someone else can explain that in a couple of paragraphs if asked).
5) What are the demands now on the table?
A) The Repubs are, as I understand it, willing to increase the debt ceiling by $2 trillion if the budget deficit is reduced by an equal amount and that must be done by cutting spending. The Dems want to accomplish the same goal by also increasing some taxes.
6) Why is $2 trillion the important number?
A) The cynic in me believes that that is the number that will get us beyond the 2012 election.
7) How often has the debt ceiling been raised?
A) I believe the number is 117, but I am not sure. 5 times under Bush and 2 times under Obama.
realjohnboy
 
  1  
Reply Tue 28 Jun, 2011 04:54 pm
@Cycloptichorn,
I am working on laying the groundwork, Cyclo et al, for the consolidation of this topic from other threads. I thought the Q&A format might be useful both for asking questions and posting opinions.
Thread under construction but feel free to head in any direction.
0 Replies
 
Cycloptichorn
 
  1  
Reply Tue 28 Jun, 2011 04:57 pm
Quote:
Why Obama May Stall the Debt Talks
Going slow is in the president's interest.


http://cdn-media.nationaljournal.com/?controllerName=image&action=get&id=7637&format=homepage_fullwidth
President Obama speaks about fiscal policy at George Washington University on April 13, 2011.

By Marc Ambinder
Updated: June 28, 2011 | 1:16 p.m.
June 28, 2011 | 6:00 a.m.

The two principals in the debt-ceiling talks, President Obama and House Speaker John Boehner, began talking on Monday with the same deadline: August 2, when the federal government will default on its debt. But Obama’s clock is running slower. And that means his leverage may ultimately be greater if he waits for several weeks before making a deal.

Obama’s political apogee will be in late July, when, if there’s no deal, the bond market will begin to panic, leading interest rates to rise and the stock market to fall. That’s when the public will begin to understand what happens when the U.S. can’t make its payments to creditors. That’s when the president can use his bully pulpit to call for an adult conversation.


That’s why Republicans want the White House to focus on vote counts right now. What combination of policies will exceed the necessary threshold for passage in the House and the Senate? Boehner is willing to concede that a debt-ceiling deal based on Rep. Paul Ryan’s budget plan may not get 218 votes. And Republicans have already conceded that they’re willing to cut significantly from defense appropriations to get them.

What Boehner would like the White House to concede early is that its effort to, say, end oil-company subsidies, raise taxes on individuals making $500,000 and up, or curtail sugar and ethanol tax breaks, would also fall short. If the vote were tomorrow, he’d probably get a higher spending-cut to deficit-trigger ratio from Democrats, too. He’d get close to $2 trillion in real cuts over 10 years.

Boehner's bottom line: real spending cuts that exceed the amount by which the debt limit is raised looks reasonable today. Since a large minority of his conference does not believe that the August 2 date is real, Boehner's aides insist that it's foolhardy to think they are any more likely to accept revenue raisers (including getting rid of tax breaks) as the weeks go by.

But Obama knows that vote counts in the absence of the crucible of crisis will differ when Wall Street, the U.S. Chamber of Commerce, and other traditionally Republican interests begin to nervously walk lawmakers out of their partisan garrisons.


And he’s betting that Republicans, having learned that his team is on nimble feet when it plays close to the edge of the cliff, will concede more up front than they did in December, when only the threat of a government shutdown (darn it, the Smithsonian would be closed!) loomed as the existential sword of Damocles. The longer Obama waits, the more Republicans will privately panic, knowing that their leverage decreases steadily as the weeks go by -- and exponentially at the turn of August.

Republicans have succeeded in turning Washington’s orientation toward spending, but they probably aren’t willing to blow that credibility if the endgame comes down to either a government default or an end to subsidies. That’s why, in private, Republicans want the discussion to begin with the president getting inside Boehner’s head: What can the White House offer to allow Boehner to get enough of his Republicans to go along, anticipating that Democrats will need at least a third of their caucus or more to reach the threshold? After last year’s election, overconfident Republicans assumed that Obama would not be able to broker any deal, with demoralized Democrats retrenched and the public having markedly signaled their distaste with Washington. They were wrong then and they’re trying to be more careful now.


Cycloptichorn
0 Replies
 
Thomas
 
  3  
Reply Tue 28 Jun, 2011 05:14 pm
@realjohnboy,
realjohnboy wrote:
1) Is August 2nd a drop dead date?

Yes. August 2 is a drop-dead date after which something doesn't get paid. Seniors don't get Social-Security checks, soldiers don't get salaried, debt doesn't get serviced, sick poor people drop dead because Medicaid doesn't pay for their treatment. . . . It could be any of those, or some of each, but something will have to give.

realjohnboy wrote:
3) But the world's faith in the U.S. economy will be harmed?

Not in the economy, but in the safety of US debt. At the moment, bond markets are scrounging to lend to the US government at historically minuscule yields. They are doing this because they perceive US debt as essentially risk-free. As soon as the US defaults on its debt, bond markets will know their perception has been wrong, and will likely demand substantially higher interest rates to compensate for the risk. This, in turn, will be toxic for the US economy.

realjohnboy wrote:
4) What is the difference between national debt and national deficit?

The debt is a stock, the deficit is the rate of change in this stock. If the US were a business, its debt would be its total liabilities, and its deficits would be its (negative) income.

I don't know the answers to questions 5--7.
JPB
 
  0  
Reply Tue 28 Jun, 2011 05:28 pm
@Thomas,
Thomas wrote:

realjohnboy wrote:
3) But the world's faith in the U.S. economy will be harmed?

Not in the economy, but in the safety of US debt. At the moment, bond markets are scrounging to lend to the US government at historically minuscule yields. They are doing this because they perceive US debt as essentially risk-free. As soon as the US defaults on its debt, bond markets will know their perception has been wrong, and will likely demand substantially higher interest rates to compensate for the risk. This, in turn, will be toxic for the US economy.


Exactly. A promissory note is not a plan. It's a promise.
realjohnboy
 
  1  
Reply Tue 28 Jun, 2011 05:44 pm
@JPB,
Duly noted. I mull over a new thread for more than a few hours to try to get the wording I think I want. I missed by a bit on that Answer.
The Senate and House are taking a less than deserved vacation until mid-July (a week each).
I hope that Obama will dig in his heels a bit and that both parties will realize that they are playing with fire here. I think they will end up coming to some sort of compromise which will probably consist of kicking the issue down the field until after Nov 2012. Perhaps an increase in the debt ceiling in exchange for some spending cuts plus study on others.
Cycloptichorn
 
  1  
Reply Tue 28 Jun, 2011 05:46 pm
@realjohnboy,
Why spending cuts, but no tax increases - especially on the wealthy? Why should, to put it simply, the Republican view on the way to deal with our debt be the default position - especially seeing as they only control 1/6th of the gov't?

Cycloptichorn
Thomas
 
  3  
Reply Tue 28 Jun, 2011 05:56 pm
@Cycloptichorn,
Cycloptichorn wrote:
Why spending cuts, but no tax increases - especially on the wealthy?

Because the bipartisan deficit commission under Alan Simpson took tax increases off the table from the beginning. In turn, the reason it did that was that the Republicans on this commission were partisans---and appropriately so; they all it bipartisan for a reason---whereas the Democrats were Geitneresque appeasers. Politically, Obama has no credible authority now for proposing tax increases. And that's too bad, because every responsible long-run policy will have to include both tax increases and spending cuts.
RABEL222
 
  1  
Reply Tue 28 Jun, 2011 11:22 pm
@Thomas,
Should I buy bonds now or wait untill Aug. 2nd.
Thomas
 
  1  
Reply Wed 29 Jun, 2011 06:15 am
@RABEL222,
I try not to give investment advice. But I'll say this: If the US defaults on its debt service after August 2, the price of US bonds is likely to fall.
engineer
 
  1  
Reply Wed 29 Jun, 2011 07:22 am
@Thomas,
I think the value of all bonds are going to fall. If interest rates in general zoom up from 4-5% to 10%, bonds are going to drop like a rock. Who wants a bond paying 6% when you can get 10% for US treasuries.

That said, the market is clearly not worried yet. Bond prices are remarkably stable given that both the US and Europe can see financial armageddon on the horizon.
Thomas
 
  1  
Reply Wed 29 Jun, 2011 07:34 am
@engineer,
engineer wrote:
If interest rates in general zoom up from 4-5% to 10%, bonds are going to drop like a rock.

Of course they will! That's an accounting identity.

engineer wrote:
That said, the market is clearly not worried yet. Bond prices are remarkably stable given that both the US and Europe can see financial armageddon on the horizon.

Evidently, financial markets are betting it's all theater. I hope they are right. But I'm afraid this is another instance of markets following the First Law of cartoon physics: Any body suspended in space will remain in space until made aware of its situation. With that in mind, my best guess is that financial markets will pretend to be oblivious to the problem until the default actually happens. And if and when it does, they will panic. Let's hope I'm wrong.
parados
 
  1  
Reply Wed 29 Jun, 2011 07:43 am
@Thomas,
If there is no deal in place by mid July, I would expect the markets to start to drop as quiet panic sets in.
parados
 
  1  
Reply Wed 29 Jun, 2011 07:48 am
I had posted these numbers on another thread, but they are relevant for the topic here.

From the US budget at the Whitehouse.gov website

2011
Projected Receipts - 2173

Budget Numbers for 2011
Interest on debt -206
Medicare - 494
Social Security - 750
Defense budget - 739
Total - 2189
Not quite enough to pay those unless tax collections are ahead of projected.


Veteran's administration - 124
and roads - 92
and FBI, ATF and all other federal law enforcement and courts - 57



Either we don't pay our soldiers or we don't pay our seniors or we don't run our country at all. Those are the choices if we don't raise the debt ceiling and don't default on the debt.
0 Replies
 
Thomas
 
  1  
Reply Wed 29 Jun, 2011 07:49 am
@parados,
I never thought I would say that, but your faith in markets is evidently stronger than mine.
 

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