Monday, October 14, 2013

Debt ceiling collision risk is being underestimated

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".


  1. All the US government has to do is to raise the taxes a couple of percent and the debt is gone in a couple of years. The taxes in the US are comparatively low so they have space for maneuvers. They only need to sell it to the public

  2. A very good article. However, eventual US default is highly likely whatever happens with the debt ceiling this time and there are a lot better reasons to worry about that than about AGW etc. Here is a an excellent article that points out many of the same things as this one:

  3. Thanks.

    And well, maybe it's inevitable, maybe it's not. In 2013, we saw the sequester and similar things and the budget deficit - the growth rate of the debt - was halved overnight. One more step like that and the default will *stop* getting closer.

  4. Hi Lubos,
    It's true, over the years many articles on this blog put perceived threats into perspective and showed their real relevance to me much less than common lore would have it. I believe this meme applies in the debt ceiling discussion as well, so it's very interesting if you disagree this time.
    Let's look at the numbers: The IRS collects about $250b in taxes a month, less than 10% of which (or about $23b) are needed for interest payments on US treasuries. In total, the US government spends close to $350b a month, however. (Average of >~ $1T deficit a year.)
    Hence, no matter how incompetent Mr. Lew's employees might be, they'd have to be hell bent on missing a coupon payment. This cannot happen inadvertently.
    If the government will be forced to live within its means come Thursday, that'll be a very healthy experience for the current leadership. Sure, it'll create some confusion, perhaps even chaos, in some agencies. It's the kind of feedback we have been lacking so desperately in recent years teaching politicians about the meaning of the money they spend.
    My biggest concern is that the Republicans will fold for some irrational reasons and abandon a just fight for fiscal sanity. And that's definitely a possibility, unfortunately.
    Here is the link to another good article on the topic:
    Best, Tobias

  5. Democrats are teenagers and Republicans adults? Do you mean those Republicans who claim that E=mc2 is a liberal claptrap? :-) You must Lubos admit that you won't find such staggering idiocy among the Democrats

  6. For every $2 the IRS collects, the government spends roughly $3. That's obviously not a fixed by a "few percent" tax increase. The whole global warming scam is at least as staggering an idiocy...

  7. I am sure that if we left out our political sympathies/antipathies we would agree that to have a good budget you need to insure that your income is bigger than your expenditures. It is no rocket science but a common sense. So how to remedy a debt? Try to increase income and decrease spending. That is what the US and also all the EU governments should do. The debts are suffocating, you need to pay high interest rates every year. The common sense people among the Republicans and Democrats should find some compromise to solve the problem together. The Republicans shouldn't block raising taxes and the Democrats should work on cutting spending to generate a surplus and use it to pay the debt. The same recipe for the Czech Republic where we have a very similar problem, only we don't spend for wars but for social system, pension system etc.(and a large sum is diverted sideways by the politicans, oligarchs and their friends) I would even go as far as to fix pensions to the budget, i.e. make the state pensions dependent on the money collected so that it doesn't generate deficits.

  8. In making sense of the shutdown, the most likely outcome is to
    orchestrate and empower the Great Betrayal (Obama's Grand Bargain) and
    it seems not unlikely that both sides in this play will converge right
    there. Medicare and Social Security being well-thought out and valued,
    extremely popular programs are undoubtedly the real targets. We know
    Obama has been aiming at them from Day 1. As for Obamacare, the program
    seems so poorly conceived and meanly designed, it will have trouble
    surviving long term.

  9. strictly speakingOct 15, 2013, 12:09:00 AM

    To anyone who's still coming to grips with understanding the current situation, I suggest watching this video.

  10. Two things should be kept in mind here:

    1) Markets are always nervous if anything serious is about to happen but they are not nervous now.

    2) The GOP is taking the blame by a pretty wide margin for the impasse.

    A deal will be made and the GOP will be doing most of the giving, like it or not.

  11. The video is inaccurate and incomplete - see cynholt's post below for a partial explanation.

  12. "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."

    If the decision was on these considerations only, I wouldn't mourn for Obamacare in any sense. But the Democrats pretty much can't capitulate on Obamacare without setting the precedent that 1/6 of the government can completely bypass and void the legal decisions of the rest (incl. both the other half of legislative branch and the judicial branch that upheld it) by holding the economy hostage.

    This country's system of government is based on checks and balances, and the situation a section of the Republicans are trying to force is a direct attack on it.

  13. I don't own any individual stocks now and I am not trying to trade as a sport or science. So it's mostly Czech cash with 1/3 of stock funds covering pretty much uniformly the whole world, with a slight Eastern/Asian bias.

  14. Here is another perspective:

  15. This is a staggeringly idiotic statement. The US's debt is presently approximately the size of it's economy. In order to raise enough money to pay for that in two years you would have to have the revenue as a percentage of GDP be about 50% *assuming you spend 100% of ALL revenue ONLY on paying down the debt*. Historically, irrespective of the tax rates that the government has set, the federal government has pulled in on average 18% of GDP in revenue, and never more than about 20% of GDP in revenue. This means that one would need an entirely new tax system if one were to try to pull in 50% of GDP in revenue-simply changing the rates to be higher in the current system just won't work, besides which one is virtually guaranteed to immensely hinder the economic activity by doing so-remember, *NONE* of that half the economy returns to the consumer through transfer payments, it *ALL* must pay down the debt.
    Even assuming it were true that the US "could" theoretically raise revenues that high, it would have to cease all other government expenditures. Defense spending, Social Security, Medicare and Medicaid, and yes even Obamacare, all of it would have to stop, immediately. Only then, and only with the US government eating an unprecedented share of the US economy to do so, could it be possible to pay down the debt by taxation in such a short period.

    In short, the scenario you have described flat cannot happen. You have vastly underestimate the scale of the problem, you are totally ignorant about how easy it would be to increase the amount of revenue to the government, and you are just generally, a complete f*&%ing moron.

  16. By "a couple of years" I didn't mean two but maybe 15. And I don't know the situation in the US as much as you do (the tax system, the politics etc). The last time I was in the US was in 2002, I had a student summer job and paid maybe 15% in taxes which is ridiculously little in comparison to Europe. I now pay 40% in taxes. That is why I wrote that there is room for maneuvers in raising the taxes. There are many ways how to do it, you can raise the value added tax which is in the US almost nonexistent or 5% but in Europe it is 20%. I (and most investors) believe that the US economy is relatively healthy and if the government takes reasonable measures the debt should be payable. There is no other solutions than to raise the taxes, cut the spending and maybe in 20 years the debt will be repaid.

    And you should check your emotions and show some Christian love, if you really are a believer. Most of conservative believers like yourself are pretty intolerant, hateful and quite dumb (taking Bible literarly is a sign of some serious failure of critical thinking). I know that if you were raised in such a family it is difficult to break free, but you should try. I doubt the Christ would enjoy the company of conservative Christians hating homosexuals, hating aborting mothers, hating atheists, hating liberals. He would call them hypocrites and throw them out of the temple because they haven't understood his true message.

    Contrary to what I wrote above, I am not an atheist. I am a mystic, i.e. prefer direct religious experience of the Devine without the need for any idolatric Church. And I prefer atheists over most believers because they are more open-minded.

  17. Are you in the habit of assuming everyone who has the nerve to disagree with you when you haven't got a clue what you are talking about must be a Bible thumping Christian? Because I haven't said anything about any of what half your post rambles on about like an obsessive mad man. This is actually another very good reason to call you a moron.

    I would suggest if you admit to not knowing anything about US taxes you either educate yourself on the relevant data or shut up.

    At any rate there is quite a large difference between the claim that one can just raise taxes and quickly pay off the US debt and your claim now that it would take a significant amount of time and some spending cuts as well. You are still hopelessly wrong because you haven't actually examined the problem beyond armchair pontification based on some naive anecdotes about how much you personally paid in taxes.

  18. It's a good distraction but I ain't gonna fall for it and neither would anyone else who can separate unrelated ideas in discussion. I can assure you I didn't even give a shit about that comment nor would I regardless of how I may feel about issues that have exactly nothing whatsoever to do with the question of how to resolve the debt issues.

    And of course an anecdote is "accurate," the issue is that it is not data. The data on effective tax rates doesn't really tell you anything about how easy it would be to raise the overall tax burden on people in the US even if we take for granted that would be even remotely desirable.

    Regarding *that* question, I would encourage you to educate yourself as to what the data suggests can actually be accomplished by realistic changes to US tax policy. I think you will find that in the US, raising the tax burden from federal taxes is much more difficult than you may naively believe on the basis of the fact that some other countries have hire tax burdens.

    I would also invite you to educate yourself as to the consequences of a heightened tax burden.

    I wouldn't ask you to show deference just because you are a foreigner. Or at all, if you just came to know what the fuck you are actually talking about.

  19. Dear Mephisto,

    Conservapedia is not a Republican website. Their article on relativity is 100% crap but so what, the Internet is full of craziness and some of it comes from people calling themselves conservatives. Among
    Democrat voters (for the most part slackjawed, drooling knuckledraggers whose arms hang so low they wear grooves into the ground wherever they go) you will find the highest proportion of people who have never even heard of SR or GR, let alone know enough to formulate a critique or find a webpage that contains one. (My comment applies, mutatis mutandis, to people voting for communist or post-communist parties in the beautiful Czech Republic.)

  20. I'm thinking if the debt ceiling is breached or defaulted (which is kind of impossible per Cynthia's post - which I agree with) the US Gov bureaucrats will go without pay for a few days. Maybe a week.
    I can't see people losing more faith in Mr Hope'n'change. That went under the bus before the last election.

    OTOH Obamacare will kill Americans wholesale. The guilty parties will never be brought to justice because the death certificate will read "died of natural causes".
    Medicine will be doled out on a purely darwinian model. Those of us with disposable funds to pay a $10k deductable will be treated to whatever medical skills survive the Civil Service entrance exam, maybe to get better.
    The vast majority living paycheck to paycheck, maybe they'll find a competent back alley doctor if they get sick or injured.
    More likely though they'll go untreated, living a short miserable life before they succume to their kidney stones.

  21. papertiger, I don't know that much about Obamacare, but I believe that one of the root evils of the US healthcare system are the parasitic lawyers
    The legislation should be changed in such a way that these parasites do not profit anymore and are prosecuted in the case of fake malpractice lawsuits.
    The direct and indirect costs are enormous. The direct costs go to the lawyer machinery, the indirect costs are reflected in the unnecessary examinations that the doctors perform to protect themselves, cover themselves. The doctors need to pay higher insurance and all this makes it expensive for the patient.

    Of course I do not want to say that malpractice doesn't happen or that it shouldn't be punished. I am just pointing out the problems.

    And I do not know the details of the Obamacare, but I believe that a universal healthcare based on social solidarity is superior to pure market solutions and it is also cheaper.

  22. As far as what you say about lawsuits, you are surely correct, but you are quite mistaken about socialized medicine being in any way superior to an actual free market in health care. It needs to be noted that long before Obamacare the US has been experimenting with increasing levels of government intervention in the health care market. Even so, as it always is, a "capitalism" even when it is actually a mild socialism, is superior to out right socialism in all respects.

  23. The explanation offered is simply too simple-minded to take seriously.

  24. Uhh..I think that the decrease of the growth rate of the budget deficit was by design. Next, they'll have to work on the budget deficit itself, then the pay-off of the debt. Which could be done, I think, by opening up U.S. lands to oil & gas development.

  25. Economic growth can help only if the growth of spending happens fast enough for spending as a fraction of GDP to go down. More likely politicians will use the greater revenue in absolute terms from a bigger economy to take a same size chunk out of, to increase spending at least as fast. Sadly the historical precedent indicates to me that the necessary course the government needs to take won't happen.

  26. The debt ceiling and default are two separate issues. If the debt ceiling is not raised, the US will have to restrict total spending to revenues. The debt itself is constitutionally protected and must be serviced regardless. If Obama refused to service it, that would be grounds for impeachment. Furthermore, not raising the debt ceiling would not prevent the government from NEW borrowing. It would merely replace current debt that had been paid off.

    The real kicker is other spending. Planned increases would not occur, and discretionary spending would have to be cut. And that is the issue. The result might be substantial disarmament. There is some discussion in the US that total US forces might be cut in half. The US would then be a regional (not global) power similar to China, and various regional bad guys would have a free hand. Welcome back to the Warsaw pact, and what is this nonsense about Baltic states being in NATO. The prodigals Belorussian and Ukraine are welcomed home.

    And you are overlookiing the sequester, which is cutting spending continuously.

  27. I've seen a documentary about "the future currency crisis". Could this be what triggers that?

  28. Are you sure it is the 14th amendment?

    I couldn't see anything in there which obligates the US to debt holders over other creditors. I only saw this under the 14th:

    "Section 4.

    The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be

    I don't see how that obligates the U.S. to debt holders over other creditors. A VERY quick scan over the rest of the document didn't reveal anything either.

    Note, I wouldn't put it past this president to default on debt holders. He'll do anything to win the house in 2014. He'll obligate his core voters over anybody else if he can.


    This short article sums up some arguments why pure markets do not work in health care. The arguments are correct and I agree with all of them. Some people (for example children with genetic diseases) will never be profitable, but the purpose of free market entrepreneurs is to make profit.

    And if the arguments don't convince you than look at empirical evidence. Most European health care systems are twice as cheap as the US system and twice as efficient (in terms of general population health).
    Of course the US is leading in medical research and if you have enough money you can get the best treatment in the world but that is a different chapter. I do not count medical research as a part of the healthcare system

  30. UPS has never delivered a neighbor's package to me by mistake.

  31. Here is something interesting although not really surprising to most readers of this blog:

  32. Interesting. Yale's Dan Kahan drew some other histograms, too:

    The Tea Party correlation is somewhat impressive, especially at the bottom part of the spectrum: the percentage of Tea Party folks whose science literacy is just the lousy 3, 4, or 5 out of 21 seems to be 2 times smaller than among non-Tea-Party members!

    These columns 3,4,5 probably contain the bulk of the folks who believe that there is a coming climate or other Armageddon whenever someone tells them a similar thing.

  33. At least Chinese rating agency Dagong degraded US to A- with negative outlook. This theatre around the debt ceiling is just that - a theatre. Republicans made fools out of themselves (if they ever needed it remember J Boehner saying "This is not a damned game"?)

    Well, to was. The real problem is that the debt is increasing with no sustainable solution in sight. Well, few things Western Culture does are sustainable.

    Lets wait till february till another circus starts, haha.



  34. What a ridiculous bunch of horse shit. You obviously haven't got a fucking clue how markets work and neither does that asshole.

    There is no empirical evidence. Not only is that shit you are saying not true, the US system is not even close to market health care.

    I would advise you in the future, next time to want to spout socialist propaganda, to save it for someone who is dumb enough to buy it.

  35. Oftentimes, infrastructure development isn't profitable in the free
    market, Lucretius. Which is why the private sector is reluctant to sink capital
    into infrastructure projects, that are more capital intensive than what
    is required to repair a covered bridge in the country or build a brand
    spanking new shopping mall in the suburbs. They only do so if these
    projects are subsidized by the government, preferably with a
    privatized-profits, socialized-losses agreement with Uncle Sam. Think
    healthcare, think roads and bridges, think nuclear power, and even think
    banking, and you'll have an immensely hard time disagreeing with me.

  36. Cynthia, if you read my reply to you with a little care, you should notice that I was not disagreeing that some government role in the economy is sometimes needed. There are, indeed things that are needed but cannot be provided profitably, and there are even certain activities which probably we do not want to engage in for profit (like policing or conducting wars).

    My only point was that you claim that a person who is against public built infrastructure or whatever is a hypocrite for making use of it, even if no private alternative exists, which is often because the government does not permit it to exist or because government competition makes it unprofitable for private alternative to emerge.

  37. Fair enough, Lucretius. Monopolies often occur when public services are run exclusively by government, but privatizing public services rarely
    reduces monopolies. It just shifts them to the private sector. For
    instance, the IT firm Deloitte and Touche (D&T) was awarded a $100
    million government
    contract to build and maintain the healthcare exchange website for
    Washington State. Anybody
    who has worked with this type of contract knows that they often
    escalate 100, 150, 200%, so this contract alone will likely go way
    $100 million. NPR mentioned that the D&T contract was one of many
    contracts for ACA bureaucratic tasks.
    Since Washington
    State holds slightly more than 2% of the US population, multiply $100
    million x 50 and the ACA is spending at least $5 billion to get the
    states' websites off the ground. This is just one of many more examples which proves that publicly-funded monopolies are very profitable for the private sector.

  38. I get your point, Lucretius, and I respect it, but I'm still not convinced that
    privatization is the way to go. Perhaps if the private sector could out
    compete the public sector in terms of providing public services at a
    lower cost while maintaining quality at a reasonable level, then I might
    be sold on the concept of privatizing all things public. But fraud and
    corruption that exists between government bureaucrats and private
    contractors is so enormous and so entrenched that we are better off
    keeping public services in the hands of government employees.

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