The (many) perils of a debt default, explained by an economist
"If we default, even a little bit, we’re going to be paying a long-term price," Eric Leeper tells us.
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By refusing to authorize the government to pay its bills unless the Biden administration agrees to significant spending cuts, House Republicans are holding the American economy hostage. And time is running out — Treasury Secretary Janet Yellen says cash could run out as soon as next week unless a debt ceiling deal is reached and approved by Congress, or the administration figures out an unconventional way to bypass Congress and raise funds.
In short, we’re standing on the precipice of a calamity that could tip the country into a sudden recession and dislodge the US from its familiar position at the center of the global economy. A default would be one of the most disastrous governmental own goals in history. And yet as the below clip illustrates, Republicans like RNC chair Ronna McDaniel are barely trying to hide their glee over the possibility that tanking the US economy will hurt Biden’s reelection prospects.
House Speaker Kevin McCarthy wants Americans to believe that reining in Democratic spending is the real emergency, but that’s a canard.
For one, Republicans could easily raise revenue by allowing the Trump tax cuts that disproportionately benefit the wealthy and blew a hole in the federal budget to lapse. But they refuse. Second, it’s worth keeping in mind that while Trump was president, Republicans voted to raise the debt ceiling three times without conditions. And finally, Trump increased the national debt by around 25 percent during his time in office, making him far more culpable for the US’s roughly $31 trillion in debt than Biden is. There’s absolutely no good reason for the US to default right now. But because any debt ceiling hike must get congressional approval, Republicans have leverage, and they’re using it to try to make life tougher for people who rely on federal programs to do things like eat and go to the doctor.
In the background of all this political wrangling is an important economic debate about how significant the national debt really is. A government is not a household; it’s not necessarily the case that policymakers are failing to live within their means by continuing to borrow. But at the same time, bringing spending more in line with revenue is obviously a more sustainable path than becoming increasingly indebted to adversarial nations like China.
RELATED FROM PN: Why a debt default would be monumentally stupid
So to better understand how we should think about the size of the national debt in the context of the current crisis, Thor connected with Eric Leeper, an economics professor at the University of Virginia who has written extensively about these issues. Leeper explained why a default would be disastrous, but also made a case that the country would be well served by elected officials coming to some sort of consensus about the goals of fiscal policy — even if that isn’t politically feasible in these highly polarized times.
A transcript of their conversation, lightly edited for clarity and length, follows.
Republicans say the national debt is a big problem. Is that true?
This whole impasse is symptomatic of a larger issue that’s only going to grow bigger as the population ages and the polarization that we have widens. There’s basically no consensus on what the role of or the goals of fiscal policy should be. Not every country is like that. There are countries where there seems to be some consensus on aspects of fiscal policy. There’s never going to be consensus on distributional matters — how income is distributed, who should be paying taxes, who’s getting benefits. That stuff is always going to be political, but we can’t even seem to reach a consensus on how much debt is too much debt.
We pin everything on what I call the “Hamilton norm,” which goes back to Alexander Hamilton. In 1790, his first report to the Congress emphasized the importance of having safe and secure public debt, which wasn’t a given back then. In fact, there was a lot of heat and debate when the federal government absorbed state government debt. People said, “Let them default.” Hamilton said we need safe debt. He had this vision that held that when the government can issue safe debt, it can serve as the foundation for financial development. His vision has been realized.
US treasuries are the world’s go-to safe asset. The dollar is the reserve currency. All of that needs to be front and center when we think about how much debt is too much and if we should be talking blithely about defaulting. If we default, even a little bit, we’re going to be paying a long-term price.
If we see the US default, then people will realize the US can and will default. The status of US treasuries will change, perhaps permanently, certainly for an extended period. US treasuries will no longer be deemed “safe assets,” and their newly-discovered riskiness will get priced in through higher real (after-inflation) interest rates as lenders demand to be compensated for taking on the additional risk.
Investors may begin to regard some corporate bonds — Apple, for example — as safer than treasuries. This diminishes demand for treasuries and makes it more costly for the US government to borrow in the future. More tax revenue will have to be diverted toward paying interest on the debt, leaving less revenue for other types of federal expenditures like education, infrastructure, welfare, defense, and so forth.
A more urgent price stems from how treasuries get used in the financial system as collateral.
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