How we got into this fine mess

By Felix Salmon
July 25, 2011
Jim Surowiecki.

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For a clear, powerful, and erudite short take on the current debt debacle, there’s no better place to go than Jim Surowiecki. His main thesis is pretty much impossible to argue with: that the debt ceiling should be abolished. If Congress wants to cap the government’s borrowing, it can and should do that in the budgeting process, not with a saber-toothed ceiling which risks devastating the entire global economy.

The debt ceiling, it turns out, has been a dangerous anachronism for almost 40 years now:

Congress used to exercise only loose control over the government budget, and the President was able to borrow money and spend money with little legislative oversight. But this hasn’t been the case since 1974; Congress now passes comprehensive budget resolutions that detail exactly how the government will tax and spend, and the Treasury Department borrows only the money that Congress allows it to.

There’s an important lesson here. For 37 years, the debt ceiling has provided an easy way for the party which isn’t in the White House to posture politically against the party which is in the White House. Even Barack Obama voted against raising it, once. Every one of the dozens of times the debt ceiling was reached, there was a small but non-zero probability that something disastrous would happen. And each time, disaster was, predictably, averted. It’s a classic sign of how tail risks are treacherous and breed invidious complacency. We’ve reached the debt ceiling dozens of times; nothing’s ever happened; so there’s nothing to worry about; so there’s no point expending precious political capital doing the right thing and abolishing it.

And now we’re paying the price. It’s increasingly looking like the best-case scenario is that America simply loses its triple-A credit rating — something which in and of itself will be pointless, dangerous, unnecessarily expensive and potentially catastrophic. The worst-case scenario, of course, is an outright default.

The lion’s share of the blame here belongs with the Republicans in general, the House Republicans in particular, and the Tea Party caucus within the House Republicans most of all. But it’s not like these people’s existence or intransigence was any great secret. And so the White House tactics over the course of the past few months look dangerously naive.

Bear with me on a short digression here. Back when George W Bush enacted his first big round of tax cuts, Paul Krugman wrote a column (I can’t find it right now, Google’s new algorithm hates pulling up old content) saying that, in effect, Bush had made Clinton look like an utter chump. There’s no point in Democratic presidents practicing fiscal responsibility and balancing the budget, he said, if their Republican successors are just going to come along and squander all that hard-earned fiscal rectitude on dangerously large tax cuts for the rich.

That kind of thinking helped to set up a vicious dynamic — Republicans would increase spending and slash taxes, while Democrats would increase spending and leave taxes untouched. It’s something which is certain to end in tears sooner or later — something the responsible people at Treasury know full well.

Which brings us to the current debt-ceiling debate. The budget debate, of course, sets near-term taxation and spending. So seeking to make a virtue out of necessity, Treasury entered negotiations over the debt ceiling to do something longer-term: to put in place a decade-long “fiscal straitjacket” which would constrain future Democratic and Republican administrations alike. That would address the Krugman point, and help to cement — rather than weaken — America’s triple-A credit rating.

As things turned out, of course, Treasury’s bright idea backfired catastrophically. Far from putting the US on a course of long-term fiscal prudence, it put the country on a log raft with no paddle, careening straight towards a deathly waterfall. In hindsight, attempting to engage the House Republicans on long-term fiscal issues was a silly idea — these are people who think you can raise revenues by cutting taxes. A fiscal straitjacket, necessarily, involves some mechanism for raising taxes; since that was always going to be anathema to the Republicans, there was no point even trying to construct one.

The cost of Treasury’s tactical mistake is going to be enormous. I don’t know how much choice Treasury had in the matter, of course: it’s possible that this particular debt-ceiling debate was going to come to tears no matter how the White House decided to approach it. But I can’t help but draw some kind of causal connection between Treasury’s oversized ambitions and the current mess. In any case, it’s a sunk cost at this point. And we’re all going to pay for it, dearly, in the years and decades to come.

Update: Many thanks to yonran, in the comments, for finding that column.

20 comments

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Another guy who defines tax cuts as spending. Republicans or Democrats, the real problem is spending, spending, spending. It has to stop. The government is simply too big and growing daily. Government is supposed to be the servent of the taxpayer, not the other way around.

Posted by BuckeyeNick | Report as abusive

I love this:

“That kind of thinking helped to set up a vicious dynamic — Republicans would increase spending and slash taxes, while Democrats would increase spending and leave taxes untouched.”

This is precisely why it’s impossible for the U.S. to ever have a balanced budget, and is why the whole debate is a complete crock. The truth is, as much as we talk about, Americans don’t want a balanced budget because they don’t want their taxes raised or their benefits cut (both of which are necessary to balance the budget).

Any candidate who ever tried to run on this sort of platform would surely be booed off the stage.

Posted by NerdWallet | Report as abusive

I agree with the fctual analysis, but disagree ith you conclusion that we shold eliminate the debt ceiling so that problem goes away. The ceiling is the only thing that prevents irresponsible, power hungry egomaniacs (i.e. Congressmen and Senators) from driving us into hyperinflation. Yes, this is difficult, but it actually makes them take a stand, makes the public look at that stand and makes everybody start thinking about economic reality.

Americans react to disaster better than they proact to prevent them. If we want to truely solve our “borrow as we go” mentality, something financial needs to blow up. and the sooner it does, the sooner we can start healing the economy.

This mess is about politics and phsycology, not economics and finance.

Posted by dhiorth | Report as abusive

@dhiorth So by your logic you think the only way to get Americans to change for the better is through catastrophe? Just making that rationalization shows how totally insane and egomaniacal are… no wonder so many are Christians, they really think America is the center of the universe!

Posted by CDN_Rebel | Report as abusive

You haven’t address what is behind all the Republicons are doing: stealing workers retirement funds.The surpluses Clinton left for Bush were enough to pay off the entire US debt by the time that the Social Security/Medicare trust funds would have to be amortized for beneficiary payments, all without having to raise taxes to pay for the amortization of those trust funds. The surplus Bush inherited was made up almost entirely of excess payroll taxes building up the trust funds. Bush took those excess payroll tax receipts and gave them “back” as income tax reductions, heavily weighted to the wealthy–who didn’t create those surpluses in the first place. By doing this, Bush guaranteed that taxes would have to be raised in order to amortize the trust funds. The failure to do so simply permits the Republicons to steal the money contributed by workers for their retirement. Everything about not raising taxes or limiting expenses, is about stealing our money.

Posted by bmz | Report as abusive

The Repubs are determined to do the $ overseas what they did to the economy domestically in the 00′s – run it over the cliff. A lot of this is O’bama’s fault – if he would have listened to people in the beginning and concentrated on employment, we wouldn’t be having this discussion right now. You can’t have people on perpetual unemployment and food stamps and say everything is swell. So let him take his share of the blame.

Posted by Woltmann | Report as abusive

As a non-American looking at the spectacle in Washington, I cannot help but feel a certain sense of sadness. Americans have brought this upon themselves. I doubt that many Americans understand how truly dysfunctional their country has become. Political partisanship and political polarization are destroying your country (mainly from the Tea Party/Republican Party on the right, but the left-wing carries its share of the blame as well). Good luck sorting out this mess.

Posted by Dan85 | Report as abusive

yes, the soda is flat but not because of the existence of a ceiling. The argument to remove it as is as shallow as the argument to get rid of MTM accounting 3 years ago. All it wil do is let you kick the can down the road a bit longer.

Posted by Tseko | Report as abusive

Felix, good analysis of the political aspects, but you completely missed what really did get us into this mess: 35 years of consecutive trade deficits. It’s no mere coincidence that our cumulative trade deficit of $11 trillion since our last trade surplus in 1975 closely matches the growth in the national debt over the same time frame. The government uses deficit spending to offset the negative consequences of the trade deficit. It’s impossible to balance the budget without first restoring a balance of trade.

Posted by Pete_Murphy | Report as abusive

Yo, Cat Fish!
Don’t you know that as a financial or economic commentator that you’re not allowed to openly state the truth?

While you’re on a roll, how about just plainly covering the Class Warfare Between the Rich and Poor? The rich have been taking from the middle class and poor for years and the poor keep voting for them to keep taking!

America as we once idealized it is no more. “General welfare” from the Constitution has been redefined as welfare for the rich and super-rich.

Posted by ptiffany | Report as abusive

Appalling exercises in magical thinking – in face, magical arithmetic – on the part of our Tea Party Patriots. A default would be an astounding abdication of Congressional authority on the part of Congress. Who will make the decisions about who will get paid, when and how much? The executive, with no Congressional oversight. It seems that Obama would be complete within his rights to turn off the air conditioning in the House of Representatives and stop paying the Supreme Court clerks.

Posted by frit | Report as abusive

I found lots of Krugman’s columns on the tax cuts but could not see one where Bush made Clinton look like a chump. This one was most interesting… albeit long. The last page was very prophetic. (or rather his last 4 pages)

http://www.nytimes.com/2003/09/14/magazi ne/the-tax-cut-con.html?pagewanted=19&sr c=pm

Posted by hsvkitty | Report as abusive

How we got into this fine mess seems like a convenient cover for the fine mess that exists now. Don’t you remember how Congress with Clinton’s help decided that everybody needed to own their own homes via the Community Reinvestment Act? To accomplish this didn’t they set up Fannie Mae and Freddie Mac to absorb all these marginal loans from unqualified borrowers many of them with no down payment?

Nothing is mentioned about this even though the article is entitled: “How we got into this fine mess.” Perhaps short or skewed memories like this is the real reason we got into this fine mess.

Posted by ponder | Report as abusive

Well done Sir. It gives me great comfort to know that only intrepid reporters create the actual word pictures. It’s up to the citizens who are active in their own local sphere of influence that anything can get done. The people have been watching the hour glass enough…wake up! Wake up! Wake Up! Go and greet and meet your representatives now. Ciao!

Posted by Jlmeshell | Report as abusive

In the future–before the Republicans want to start another war (and John McCain would like one in Libya while Ron Paul has his eye on Iran), the GOP should specify in advance what taxes will be raised to finance the war. You cannot fund the budget on program cuts alone while exempting the DoD and providing obscene tax breaks to the wealthy. Face it, Republicans like to spend money as much as Democrats (How much does a B2 cost again?) This is why George Bush the elder called Reaganomics “Voo doo economics.”

Both sides have to give a little–that’s only reasonable. Unfortunately, the right has become unreasonable.

Posted by gangof4 | Report as abusive

Good analysis, but as with a lot of other commentary, it rests on the untested assumption that the bond market is rational and omniscient. Perhaps this assumption should now be known as the efficient markets fallacy.

Indeed I think it rather dangerous to speculate that, simply because yields have failed to climb, investors have by definition concluded that the probability of both imminent default and future default (rendered more likely by increased political polarization) are low.

On the contrary, I find it rather more likely that investors are every bit as asleep at the switch as they were in 2008 and have underestimated the Tea Party’s apparent willingness to escalate what would otherwise be an ordinary costume drama into a match to the death at the Colosseum. If and when they finally wake up, the results could be very unpredictable.

Exactly how the Obama administration was dumb enough to fall into this trap may very well become a topic of debate for decades. If you’re as terrible a negotiator as Obama, the last thing you ever want to do is invite the barbarians over for dinner, when it’s as clear as day that as soon as they arrive they will burn the house down.

Posted by David4321 | Report as abusive

Well heck yeah. I mean we’re going to be doing this same thing again and again even if we pass 20 trillion in cuts over 10 years. In fact, just how much would we have to cut, now, to actually avoid a vertical takeoff and landing when Medicare begins to have 50 million boys and girls added to it’s rolls who if not already employed, will be way too old to work at any kind of job, even if there were any?

Posted by threeRivers | Report as abusive

Oh boy, its hard to imagine Treasury is that D-U-M dum. Surely the policy came from next door at the White House. Then again, they seem to think hitting the debt default wall is preferable to going around it by using th platinum coin seigniorage powers Congress gave them, so there’s no telling.

Of course, as New York Fed chairman Beardsley Ruml told the ABA in a 1945 speech, “Taxes for Revenue are Obsolete”. The purpose of (federal) taxation is to regulate aggregate demand. The optimal solution is for the Fed toy tighten or loosen our fiscal stance just as they (ineffectually) adjust monetary policy. Indeed, the Fed already has that power. 1. Since 1947 they’ve refunded their net earnings to Tsy, 2. Since 1980, Congress has authorized the Fed to levy and adjust its own transaction fees. Combine the two together: even as Tsy spends what Congress appropriates, the FRB can adjust its transaction fee schedule, mark up fees for a net drain of reserves, mark down fees for a net add. The fee revenue generated would be forwarded to the same destination as tax payments, Tsy General Account.

In 2005, UW-Madison Econ Professor Edgar Feige laid out for Bush’s tax reform panel something like this in his Automated Payment Transaction (APT) tax proposal. Of course, Feige missed the point that his plan for the Fed to collect taxes on behalf of Tsy is already authorized under current law.
http://www.scribd.com/doc/25299549/Feige -APT-Presentation-to-Tax-Reform-Panel-20 05

Posted by beowu1f | Report as abusive

Felix its a well structured article, but it ignores the real problem: the trade deficit US has been running for decades now. Obama got this right, when he said Americans need to export more to beat the Indians and the Chinese. But herein lies the problem – its more psychological and cultural than economic. Indian and Chinese learn to work hard and save from their parents. That’s the way they live. So India and China export. Americans on the other hand, learn to consume beyond their means. That’s the way they live. So US consumes (imports). That’s the problem that needs to be addressed. Of course it’s easier said than done. Where Obama is getting it wrong, is in focusing on cutting down imports rather than stimulating exports. Look at US’ policy in WTO, it reeks of protectionism. That’s like saying, we’re going down, but we’ll drag the whole world along.

Posted by vibhor | Report as abusive

By the way, in Google, try using the Toolbar on the left that allows you to restrict your search to e.g. news articles 2001-2007. You may be referring to Krugman’s December 2006 column on Democrats and the Deficit: http://news.google.com/newspapers?id=Qk1 QAAAAIBAJ&sjid=yQQEAAAAIBAJ&pg=6808,2704 329

Posted by yonran | Report as abusive