Two weeks ago, I discussed the partial government shutdown that was coming and it indeed came and turned out to be the non-event I expected.
However, we were also aware of another threat which is related but much larger, perhaps by a factor of 100-1,000: a collision with the debt ceiling, a legally imposed upper limit on the amount of the U.S. public debt. We're now just 3 days away from the expected D Day even though the U.S. debt clock tells us that the threshold at $16.699 teradollars has already been breached. ;-) There is no deal so far, tensions are running high in the U.S. capital, and people outside D.C. are incredibly calm.
You will probably agree that I am almost always much calmer than the average person when it comes to alarms of any sort (and I have always been right so far). People worry too much. They love to scare each other and they love to be scared. At some point, I may have been worried about the Iranian nuclear bomb more than you were but those worries of mine decreased, too.
But this time is different.
I am actually surprised that people are so calm when such a catastrophic event seems to be coming so soon. When irrelevant European economies and islands showed just superficial signs of problems, the global markets reacted hysterically. Now, the government of the world's largest economy is on its course to hit its debt ceiling and no one seems to care. Dow Jones is just 4% beneath the all time high and it is changing just –0.2% today (update: +0.2%). Currency exchange rates are not moving. Newspapers aren't full of news about the developments.
As some pundits have observed, the shortage of anxiety means that there isn't a large pressure on the lawmakers which makes it more likely that they will fail to find a solution.
I have already made it clear that the task to avoid "fast problems" on the daily basis – and the potential default is a textbook example – is exactly the job for the administration, the executive part of the government. I am convinced that – and I would be saying the same thing if the Republicans were controlling the White House – that it's Obama's responsibility to avoid the default if he thinks that it's the worst possible outcome.
The lawmakers are supposed to control the government at longer timescales and they are expected to place obstacles in front of the government to defend their long-term goals and values. After all, the debt ceiling itself is such an obstacle, a law that protects some people's long-term interests. So it's completely normal that the party that controls the House may use the threat of problems arising from a constant debt ceiling to demand some concessions – to demand a ransom, if you wish – from the party that controls the White House. This is how the political system is supposed to work. One may use diplomatic and euphemistic or tough, dramatic, and insulting words to describe the same principle but the choice of the words doesn't change the essence (even though some more naive voters may be immensely impressed by one choice of the words or another). Demanding a ransom is a normal part of the political process in a democracy. It's how the deals are being done. And they have to be done because no one's power is absolute.
The Democrats arguably don't have a sufficient power to avoid the default and similar problems and to bring the Obamacare to force. They should realize it. And if they agree that the default would be a worse outcome than the abolishing or at least postponing of the Obamacare, they should simply surrender the Obamacare or at least its fast timing.
Now, I agree with those economists who say that when the government runs out of funds in a few days, assuming that the debt ceiling isn't raised, it doesn't mean a default. There are many ways to avoid it. It's clear that the payments on the U.S. treasuries should be the top priority because their failure could be rather existential for the system. These payments are more important than Medicare, Medicaid, and – sorry, emotional Donald Rumsfeld – than the fees for the fallen soldiers' families, too. I am confident that there are many competent economists who would know how to behave so that the refusal to raise the debt ceiling wouldn't represent a major problem.
However, the trouble is that I am not sure – and the Republicans can't be sure – whether the Democrat Party's economists in the Obama Administration are competent in this sense. It doesn't really seem like they know what they would be doing to avoid the most serious problems. Maybe they're bluffing and they're only pretending to be incompetent – to add some extra pressure in the form of the Republican worries – but maybe they are not bluffing. They may be incompetent. Republican politicians should know more about this question and if they know that the administration isn't too competent and is likely to do some really stupid things, these Republicans would share some responsibility for the developments if they manipulated the incompetent officials into the corner filled with stupid acts. Democrats may be teenagers and Republicans may be the adults but at some moment, an adult who pushes a teenager to do an even stupider thing is irresponsible, too.
What seems certain is that the Democrats and the Republicans genuinely disagree about rather important questions. So I disagree with the suggestions that all of this is an irrelevant political theater that is bound to have a happy end. I don't see any such inevitability. To reach a happy end, many people – and probably people on both sides – must show some good will and be skillful and hard-working at the same moment. Too many things have to work. When I sometimes face a deadline concerning a paperwork, 3 days is a very short time. And it's usually a problem that is much less complex than a solution to the debt ceiling impasse – a solution whose precise shape isn't known as of today.
So I find it moderately likely that the debt ceiling won't be raised. And if it is not going to be raised, it's moderately likely that the White House will drive America towards default. I would expect such a default to have some temporary effects and some permanent effects. It would be "partially reversible", so to say. After some time, conditions similar to the current conditions would probably get restored but the interest rates would have to be higher. The ratings of the U.S. would probably drop for quite some time even though the U.S. would probably make all the payments, just some of them would be a little bit late. The U.S. GDP would see a one-time drop by several percent. Perhaps four percent.
I am not sure whether the markets would behave rationally. A real-world proof that such an event could take place in the U.S. should undermine the confidence in the U.S. treasuries and the U.S. dollar. But many markets players could react very irrationally and still view the U.S. treasuries and the U.S. dollar as the safe haven – the place where you're supposed to hide when it's raining bad – even though the most important event would be nothing else than a proof that these American forms of wealth are not a safe haven. What big holders of the debt such as China would be doing could turn out to be very important, too.
If I were a lawmaker for the G.O.P., I admit that I would probably not have enough nerves and probably supported solutions to at least temporarily/slightly raise the debt ceiling without extra conditions. At least for one month. If I were a Democrat Party lawmaker, I would point out that my party is irresponsible and idiotic and it needs to adopt all proposals of the G.O.P. that are designed to prevent the U.S. debt from spiraling out of control. I would insist that the president from my party is ready to immediately balance the budget if it turns out to be necessary to do so.
But the partisanship in the D.C. is much more severe than we can imagine and I believe it is genuine. And so is the risk of the U.S. default. If something like that happens, I hope that the holders of the U.S.-dollar-denominated assets will realize that there are still many forms of wealth in the world that would remain "almost intact" and even the U.S. assets would eventually get "almost fixed".