Default, debt ceilings and democracy
“The growing question is whether the exceptional role of the dollar can be maintained … The growing sense around much of the world is that we have lost both relative economic strength and more important, we have lost a coherent successful governing model to be emulated by the rest of the world … Instead, we’re faced with broken financial markets, underperformance of our economy and a fractious political climate.”
University Club of New York
November 30, 2010
There were quite a few comments in response to my last post, “Why Congress should vote no on raising the debt ceiling”, about evenly split between those who find the suggestion of deliberate, voluntary default by the US ludicrous and those who found the discussion refreshing and honest.
In that vein, let’s dissect the objections of those who say that Congress “must” raise the debt ceiling in order to avoid the “apocalypse,” (CORRECTION: “Armageddon”) of debate over it, as Republican Senator and former Texas Treasurer Kay Bailey Hutchison said. There seem to be three major objections to the idea that the US could voluntarily default on its debt. First is the belief that if the Treasury was even a few days late paying its debts the financial markets and major banks would melt down. This notion is wrong.
A year or so ago, my friend, John Makin, a fellow at the American Enterprise Institute, dismissed the idea that China or any major investor can move out of dollar assets in some meaningful way. First, there is no bid for even a tiny fraction of dollar assets in other currencies. The fact of the matter is that the dollar is the world’s chief means of exchange for trade and commerce, factors far more important than financial flows. The euro could only accommodate a small fraction of dollar assets held by non-US residents.
With the EU under growing pressure from zombie banks, as per Tyler Cowen’s timely comment in the New York Times on Sunday, global investors are hardly ready to pile into the euro from the dollar except on a short term basis. Today, many EU banks are on life support, care of the European Central Bank, which in turn is held up by the Fed’s swap lines.
If the US was a few days late paying its bills, nothing would happen. The fact is that the dollar and dollar-denominated assets are the only asset class big enough to accommodate the wealth of the world, handle trade and financial flows and is politically reliable enough to be the global unit of account. This reality is changing with the emergence of some of the states of Eastern Europe and Asia, but political concerns limit the attractiveness of such venues, even for their own people.
Want to take Russian rubles instead? Go ahead. Just be ready to deal with the periodic caprice of Russia’s rulers. America’s open markets facilitate financial and commercial transactions more than any other nation and our chaotic but open politics, not fiscal factors, is why people prefer the dollar as the store of value.
Unfortunately the flip side of being the greatest currency on earth is that there is no effective limit on debt issuance and thus inflation. The freedom of the dollar zone carries a heavy tax in terms of inflation. The natural demand for dollars as a means of exchange for global commerce is so strong that Congress and successive governments in Washington have been able to borrow to finance spending deficits and bailouts without real limit.
If Washington is late paying its debts, investors will simply have to wait. Former Treasury Secretary and Texas Governor John Connally once famously told the EU nations, “the dollar is our currency, but your problem.” Remember the dollar crisis four decades ago? This leads to the second reason observers argue in favor of lifting the debt ceiling, namely that the budget process, not default or the threat thereof, is the way to address spending. We’ve been hearing that same argument in Washington for three decades and more. But Congress has made no progress on controlling normal spending and has added insult to injury with trillions of dollars in unnecessary subsidies for Wall Street. Any arguments about the efficacy of the congressional budget process are unconvincing.
To say that the US “budget process” is broken is an understatement of vast proportions. There is no effective budget process in Congress, which is all the more reason to shake things up by voting no on the debt ceiling. Why should the people of the US allow the Treasury to issue more debt if members of both political parties are so corrupt that they cannot balance the federal budget? We can live with and might even benefit from a few days or weeks of supposed chaos if we can restore fiscal discipline to American society.
Worse, Congress now allows the Fed to explicitly monetize the national debt, an act of depravity that begs the question as to whether investors ought to purchase US debt. As I noted last week, the bailout by the Fed for Congress via “quantitative easing” is far larger than any alms offered to the big banks.
Pundits who say that there should be no limit on federal spending or public debt reflect an ignorance of American history. The point of having legal limits on spending and debt is the same as having checks and balances, a rule which the founders of the US embraced as a check against both political and financial excesses.
By voting in favor of lifting the debt ceiling without requiring the Obama Administration to embrace fiscal reform, members of Congress vote for the status quo. Voting against raising the debt ceiling is voting against bailouts for Goldman Sachs, JPMorgan and other large Wall Street banks. If you like the idea of forcing the large banks to restructure their balance sheets and modify under water home mortgages, then vote no on raising the debt ceiling.
Perhaps the most specious argument used by proponents of raising the debt ceiling is the idea that the status quo of more borrowing by the Treasury and the skewed monetary policy by the Fed to monetize this debt is acceptable. Those who want to raise the debt ceiling do not want to cut spending, much less limit government’s ability to spend. Thus electing to simply continue the reckless fiscal policies of the past three decades is the path of least resistance.
Secretary Geithner wants to raise the debt ceiling because he says that America will fail if the US Treasury is late paying its bills. But it is fair to say that the US debt cannot ever be repaid in kind, only in nominal, inflated dollars. As former Fed Chairman Alan Greenspan once said to Senator Richard Shelby (R-AL) about Social Security, “you’ll get your check”. The question is what will it buy, a reference to the continuous erosion of purchasing power due to inflation.
Voting against raising the debt ceiling is a valid mechanism for forcing political change in Washington. No nation can call itself a democracy if it is not willing to reject the demands of convenience and use an occasional revolution, to paraphrase Thomas Jefferson, to cleanse the nation’s financial and political life. Of course, Jefferson was heavily in debt most of his life.
The debate in Congress over the debt ceiling is as much about the political fate of the US as the financial solvency of the Treasury. Members of both political parties in Congress should put aside the cowardly counsels of convenience, take their time and demand their price from President Obama before voting yes on even a temporary increase in the debt ceiling. It is time for Congress to stop hiding behind the Fed and to address fiscal issues head on — like the governments of every other industrial nation. If we have to default on the national debt, even briefly, to get this done, so be it. At the end of the day, the political principle involved here is more important than the financial issues involved.