Debt limit dead ends are not worth the risk

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Game theory, used to model competitive outcomes, has been the subject of 12 Nobel Prize in Economics. But my understanding of nash equilibrium and Pareto Optimity isn’t solid, I’ll admit, so the framework I’m using for the debt ceiling deadlock is a Buddy Hackett duck joke.

A hunter in the big city shoots a duck, which falls on a farm, while the late comedian explained to Johnny Carson to Tonight’s show over 30 years ago. He climbs a fence to retrieve it, but a farmer appears and says, “This is my property, this is my duck. The two men argue, until the farmer comes up with a special local custom to settle the differences: “We take turns kicking each other in the groin.

Not wanting to give in, the hunter accepts. The farmer starts off with a powerful connection, and the hunter falls down and howls for a while, demonstrated enthusiastically by Hackett. The hunter pulled himself together and said, “Guess it’s my turn.” And the farmer says, “You can have the duck.”

Hackett’s Duck Principle, if my math is correct, means that competitors need to make sure that what they are fighting for is worth it. There is an added wrinkle with the debt ceiling deadlock, in that the hunter and the farmer, in this case, risk harming us rather than each other. It’s time for an easier and safer way, which I will come to.

For context, America has imposed a legal limit on its debt for a little over 100 years and has increased that limit about 100 times. “Ceiling” is probably not the best metaphor – debt cap, perhaps. As growing partisan resentment turned everyday legislation into a fight to the death, politicians became more willing to use the debt ceiling as leverage.

A deadlock in 2011 resulted in a downgrade in the U.S. government’s credit rating, a brief but unfortunate drop in stocks, and a temporary rise in bond yields, which accountants say cost the U.S. government billions of dollars in additional interest. The result was a shaky compromise, which collapsed in 2013, but Congress had yet to regain its appetite for another round of budget chicken, so it suspended the cap. There have been numerous extensions since, the last of which expired at the end of July. The Treasury is now looking for funds under its sofa cushions. Without Congressional action, America will default by mid-October.

Debt was 35% of gross domestic product in 2007 when the first iPhone came out, but then followed two deep recessions with bailouts, separated by a series of sweeping tax cuts but not spending. This year, the debt will reach around 101% of GDP. Over the next decade, it will reach the record 106% reached just after World War II, when two in five American workers were either in the military or in ammunition manufacturing. By 2050, it could reach 195%.

Some economists, like Boston University professor Laurence Kotlikoff, calculate debt at much higher levels today, based on obligations such as projected and unfunded Social Security payments. “We are worse off than any advanced country, and this is the result of seven decades of a Ponzi scheme,” he said.

That sounds bad. On the other side are proponents of modern monetary theory, who argue that for countries like the United States that issue their own currency, the only real constraints on spending are the availability of labor and materials and the desire to keep inflation low. “Finding the votes to pass a spending bill can be difficult, but finding the money is never a problem,” economist Stephanie Kelton told a recent TED talk.

Unlimited spending is too far a bridge to monetary expansion for me. I was brought up in a mixed household—keynesian and Chicago School– and lately, I feel like I identify financially as neo-Amish. Regardless of your school, however, the debt ceiling equates to performance art, not tax restraint. The amount America owes now has already been decided by past spending and taxation decisions, and both sides have dramatically increased the overruns. The only thing the cap determines is whether we’re going to get back the money we already owe. And this, in turn, influences the fact that interest on the debt will remain unusually low.

Democrats in the Senate have exactly 50 votes needed to raise the debt ceiling through a budget process called reconciliation. The main things to know about reconciliation are that, first, it is nothing like how a functioning legislature should set a nation’s spending priorities, and second, it is not available all the time, and the fact that it can be used so late in the year is a fluke of the incompetence of Congress.

Why don’t Democrats just take action? Because they don’t want Republicans to claim later in campaigns that they tried to stop Democrats from borrowing more, but that they didn’t have enough votes. And Republicans, who just want to say that, are offering zero votes. Both parties are betting on busy and distracted voters who do not understand the trick. The leverage they use is the threat of financial disaster, and the only way to increase leverage is to make a tight call.

Germany, Netherlands, United Kingdom, Canada: Almost all developed countries manage without a debt ceiling. Denmark has one, but last fixed it in 2010, without incident, at a level well above the current debt. Congress could simply remove the cap, but neither party will risk that.

Maya MacGuineas, chair of the Committee for a Responsible Federal Budget, says the answer is to demand that the debt ceiling be raised as part of any tax cuts or spending increases that create a deficit. This would combine liability for borrowing with authorization and end deadlocks by default.

“Even though it’s only a small risk that we might default, it’s enough that we don’t let a purely stupid risk sit on the table and threaten us,” she said. “And at a time when we’re so polarized and dysfunctional, stupid things seem a lot more possible than they have been in the past.”

Write to Jack Hough at [email protected] Follow him on twitter and subscribe to his Barron’s Streetwise podcast.



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