In any negotiation, the key question is, what is the default status? That is, what happens if you don’t make a deal? If you are negotiating a business transaction (e.g., a merger), the default status is that the transaction doesn’t occur and the parties walk away. If you are trying to settle a lawsuit, the default status is that the case goes to trial and both parties take their chances. Where the default status is more favorable to one party than the other, that party has bargaining power.
With respect to the government shutdown–i.e., negotiations over a continuing resolution that will fund federal operations on a temporary basis–the default status is that a portion of the government, presumably a growing portion, remains closed down. That default status is unacceptable over any considerable length of time, and it is not favorable to Republicans. Despite the Obama administration’s blunders, voters are more likely to blame Republicans than Democrats for perceived adverse effects. It is therefore not surprising that President Obama refuses to negotiate with respect to the shutdown. He is not bluffing.
The debt limit is another case altogether. The Democrats and their press minions have gone to great lengths to convince us that the default option–the debt limit stays where it is–is unthinkable. They say that if the debt ceiling is not raised, the U.S. government will default on its debt obligations, with catastrophic consequences. But this is false. As I wrote here, there is zero possibility of a default. The federal government is constitutionally required to pay its debt obligations, and can do so easily: it requires less than 10% of tax revenues to pay the interest on our nearly $17 trillion debt, and rollovers do not increase net indebtedness. So default is out of the question.
That fact has been acknowledged, recently, by more and more observers. Here, for example, Harvard’s Martin Feldstein and Greg Mankiw note that there will be no default if the debt limit remains unchanged. More important, the market, which is driven by investors who are much more sophisticated than Barack Obama and Harry Reid, reflects the fact that there is no possibility of default. An extremely knowledgeable reader explains:
The VIX (volatility index for U.S. equities, sometimes called the “fear index”), a very sensitive measure of risk in the economy as a whole, is flat to down over the past week. Credit default swaps on U.S. government debt, essentially a bet on default, (a) have miniscule net outstanding exposure (about $3.3 billion notional); and (b) very little movement. That’s an oddball speculative trading market anyway. Most important, since risk of default would be expressed initially in a crash of the USD in currency markets, is the stability of the USD/EUR exchange rate–important because U.S. sovereign debt CDS are settled in–Euros!
There is a blip in the short end of the T-bill yield curve, which could mean anything from a short term recession forecast to changes in demand for the short end on maturity rollovers. Beyond 182 days the curve is flat.
Bottom line: essentially no market indicators of impending “default” catastrophe.
So if default can’t happen, what is the default status–a different use of the same word, sorry–with respect to the debt ceiling? If House Republicans refuse to raise the debt limit, the effect will be as though a balanced budget amendment had been passed. From that time forward, the government would be able to spend money only to the extent that it brings in tax revenues. That’s a lot of spending–trillions of dollars annually–but significantly less than what is now hemorrhaging out the door. What would the consequences be?
First, there would be no default, which would make President Obama and many others look stupid. That would not improve their political position.
Second, interest on the debt would be paid, and entitlement benefits would be paid. The government would have to start cutting back on discretionary spending. The Obama administration would no doubt do that in a sub-optimal fashion, taking money mostly from defense and secondarily from functions that will inconvenience voters. But before long, Congress would pass appropriations bills–who knows, maybe even a budget if the Democrats are finally willing!–that would direct spending in a reasonably rational direction.
Some will argue that the discretionary spending cutbacks that would occur under this scenario are no different from the selective closures that we are seeing under the “shutdown” and should have the same political consequences. But this is incorrect. With respect to the shutdown, the casual voter thinks that the government needs to be funded and fails to understand why “Washington” can’t get its act together to do the obvious. But that same casual voter is uneasy about the fact that the country is $17 trillion in debt and wants to see something done about it. The balanced budget amendment is perennially popular.
Third, the Democrats would be unable to stomach the substantial cuts in discretionary spending that would flow from a balanced budget. They would do two things. First, they would come to the table and, for the first time, be willing to talk seriously about entitlement reform. It is entitlements, after all, that are eating up the budget and threatening our children’s futures. Second, they would come up with a plan to finance more discretionary spending through higher taxes. Only now, their plan would have to be serious: with deficit spending no longer an option, they would have to admit that to pay for the lavish welfare state they want, everyone–not just the “rich”–will have to pay vastly higher taxes.
So: which party does the default status of no debt ceiling increase favor? The Republicans, obviously. We can live happily with a balanced budget at current tax rates. The Democrats can’t. This is why Obama has his state-run press working overtime to convince us that the debt ceiling must be raised.
But why should we do them any favors? The Republican House cannot by itself, through legislation, drive federal spending downward. But by refusing to go along with an increase in the debt limit, it can bring the Democrats’ disastrous overspending to a screeching halt. Why not do exactly that? With respect to the debt ceiling, unlike the shutdown, it is Republicans who have the bargaining power. Here, Obama is bluffing. Republicans should call his bluff. If he will negotiate substantial spending reductions, then the House should agree to raise the debt ceiling. If not, Republicans should stand pat: the Democrats can’t raise the debt ceiling without them. Let the chips fall where they may. There will be no default, the sky won’t fall, and maybe we finally will bring wasteful government spending under control.