SCENARIOS-Options for raising the U.S. debt limit
Posted by WARREN MOSLER on July 25th, 2011
And this and $20 will get you a cup of coffee.
I still see no sign of agreement.
Nor have I read anyone discussing the downward acceleration in GDP triggered when the spending limits are reached.
As previously discussed, GDP will accelerate as it falls, as the automatic stabilizers will be disabled.
So spending is further cut, sales go down more, more jobs are lost, and tax revenues fall more,
When the $150 billion/moth in govt spending stops in 2 weeks, sales fall, jobs are lost, and tax revenues fall, so spending is further cut, sales go down more, more jobs are lost, and tax revenues fall more, etc. etc. etc. until no one is left working.
(And it’s really bad for stocks, by the way, when no one buys anything.)
So seems they are underestimating the odds of no bill reaching the President’s desk.
And they are radically underestimating the speed and extent of the subsequent damage.
The problem is that most, probably including the President, believe the US takes dollars out of the economy when it borrows.
And therefore when it stops borrowing to spend the economy will have those dollars to replace the lost federal spending.
And so after the initial fall, it all come back that much stronger.
Except they are dead wrong.
And therefore we are all dead ducks.
Ever hear anyone ever say ‘I wish they’d pay off those Tsy bonds so I could get my money back and go buy something.’?
Of course not.
Tsy borrowing gives dollars people have already decided to save a place to go.
Dollars that came from deficit spending- dollars spent but not taxed.
If they were spent and taxed, they’d be gone, not saved.
Tsy bonds provide a resting place for voluntary savings.
They are bought voluntarily.
They don’t ‘take’ anything away from anyone.
For example, imaging two people, each with $1 million.
One pays a $1 million tax
The other doesn’t get taxed and decides to buy $1 million in tsy bonds.
Pretty obvious who’s better off, and who’s still solvent and consuming.
Someone tell the Democrats and the Republicans, thanks.
They are about to cut $150 billion/month in spending because they think it crowds out the private sector.
They really think the dollars the govt. pays out cause business to lay people off.
They don’t know that it’s that deficit spending that we get first as income that adds to our savings of govt. bonds.
And, of course, they also think they have no choice, as they all believe the US could become the next Greece, and face a similar financial crisis.
It’s completely inapplicable- Greece is like a US state, not the federal government- but they don’t know that.
No mainstream economist has pointed this out.
No one in the media has pointed this out.
So who can blame them?
I’ve never seen this kind of systemic risk looming in my 40 years in the financial markets.
So hope for the best,
and prepare for the very worst.
SCENARIOS-Options for raising the U.S. debt limit
(Reuters) – Democrats and Republicans in Congress, unable to compromise on how to cut budget deficits and raise U.S. borrowing authority, are now working on their own, competing bills.
With nine days’ left until the United States runs out of money to pay all its bills after Aug. 2, the two parties were rushing to get their respective bills moving through Congress this week. [ID:nN1E76M0B0]
Here are some scenarios for raising the debt limit by the early August deadline to avoid a potentially crippling government default:
* AN ALL SPENDING CUTS, NO REVENUES PLAN
This is the path being pursued by Senate Majority Leader Harry Reid, a Democrat.
Since tax increases that Democrats had been seeking were the major sticking point in negotiations with Republicans, Reid is simply removing the problem from the formula altogether.
Instead, he’s writing a bill that would achieve about $2.7 trillion in spending cuts over a decade while raising the $14.3 trillion U.S. debt limit by an identical amount.
If this streamlined plan were to pass Congress, there would be no need to revisit the divisive debt limit fight until 2013, after the presidential and congressional elections. Democrats would be glad to see no benefit cuts to popular Medicare, Medicaid and Social Security programs.
Financial markets would be happy that government borrowing authority is ensured through 2012.
* THE DISADVANTAGES
Some of the savings could be squishy, such as counting money not spent in the future on wars as the United States withdraws from Iraq andAfghanistan.
Also, overall deficit reduction is short of the $3 trillion to $4 trillion many had hoped for, including financial markets.
And there likely would not be anything in the plan to force future reforms of the cumbersome U.S. tax code and major benefit programs for the poor and elderly that will increasingly weigh on the federal budget.
The result could be that conservatives won’t go along.
And it’s unclear how U.S. credit ratings agencies would view the legislation.
* A SHORT-TERM DEBT LIMIT INCREASE
House of Representatives Speaker John Boehner, the top U.S. Republican, is going ahead with a two-stage program to achieve some spending cuts and a stopgap debt limit increase with plans to do another installment of both next year. He’d start with about a $1 trillion debt limit hike by Aug. 2, with a similar or greater amount of spending cuts.
Then, over the next six or seven months, Congress and Obama would fight over large additional savings — maybe from expensive benefit programs and by reforming the tax code — in order to get a second installment of the debt limit increase.
Boehner also might attached language requiring passage in Congress of a balanced budget amendment to the U.S. Constitution.
Tea Party conservatives who are important to Boehner’s political future have been pushing for such an ambitious plan and especially like the fact that it includes no tax hikes.
THE DISADVANTAGES
It is complicated, and sets up another difficult fight over the debt limit next year that could rattle financial markets. It could cause credit ratings agencies to downgrade the U.S. prized Triple-A rating.
* BLEND THE TWO IDEAS?
If the Senate were to pass the Reid plan and the House were to pass the Boehner plan, could the two be married?
Possibly. There could be a debt limit increase that carries through 2012 with no tax hikes, coupled with mechanisms to try to achieve more savings than Reid’s $2.7 trillion.
But leaders would have to work hard to find a “sweet spot” with just enough adjustments to get the necessary majorities for passage in Congress. And they’d be under an almost impossibly tight deadline.
MCCONNELL “FALLBACK” PLAN
A backup “fail-safe” plan first proposed by Mitch McConnell, the top Senate Republican, could be dusted off if it appeared the two sides could not reach a compromise on their competing bills.
Through a complex back-and-forth between the White House and Congress, it would allow Obama to raise the debt limit by $2.4 trillion in three installments through November 2012, when Obama and most lawmakers are up for re-election.
Under the McConnell plan, Republicans would not have to vote to raise the debt limit.
Obama has said that “at a minimum” the debt limit has to be raised and that he will take responsibility for that if the McConnell plan passes Congress.
House Republicans hate the plan, saying it would be a missed opportunity to get the big spending cuts they demand.
TALKS RESUME
It’s getting late to launch yet another round of negotiations, but at some point, leaders from both parties are going to have to work out either a brand new deal or one that accepts elements of their respective bills.
OBAMA INVOKES THE CONSTITUTION
This seems to be the most unlikely scenario.
Some have argued that Obama could ignore Congress if it fails to raise the debt limit and order continued borrowing by relying on the 14th Amendment of the U.S. Constitution.
The fourth section of the 14th Amendment states that the United States’ public debt “shall not be questioned.”
Obama has said White House lawyers had explored the option and they are “not persuaded” that it is a winning argument. But he did not rule it out.
July 25th, 2011 at 6:34 am
“Greece is like a US state, not the federal government”
so Greece is more politically constrained than US Treasury
but ECB no less operationally constrained than the US Fed
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anon Reply:
July 25th, 2011 at 6:36 am
meant:
but ECB no more operationally constrained than the US Fed
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Neil Wilson Reply:
July 25th, 2011 at 7:09 am
@anon,
The ECB is politically more constrained though because it is answerable to the individual state and their ‘funding’ rather than an overarching federal legislature.
Benevolent dictators are more effective than democracies – particularly in a crisis.
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anon Reply:
July 25th, 2011 at 7:52 am
@Neil Wilson,
right
but its a question of degree is the point
ECB is not operationally constrained
could have adopted the Mosler 1 trillion Euro plan is the proof
so the constraint is political, but its not absolute
its a question of degree
so you have to judge the political difference between stuff like debt ceiling and overdraft versus the difficulty of getting a fragmented Europe to influence ECB policy
fragmentation of multiple states and the ECB versus fragmenation of the Fed, the Treasury, the President, and Congress
all a question of political feasibility
not an absolute difference
not really a user/issuer difference either
CB is the issuer in both cases
WARREN MOSLER Reply:
July 25th, 2011 at 11:03 am
right
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WARREN MOSLER Reply:
July 25th, 2011 at 11:03 am
right, if I read you correctly
‘more’ meaning the body in Athens that spends is constrained by ecb policy in brussels.
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July 25th, 2011 at 6:46 am
WWFDRD? (What would FDR do?)
Is Obama an invertebrate, or have the Clinton-era retreads just sucked all the minerals out of his spine?
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July 25th, 2011 at 7:46 am
I view the possibility of a cessation in the federal deficit as an experiment.
You wrote:
________________________________________________________
They are about to cut $150 billion/month in spending because they think it crowds out the private sector.
_________________________________________________________
I think the ramifications of this statement should be addressed because there is a kernel of truth there. Whether “crowds” is the right word everyone can agree it does something to the private sector.
Currently the US private sector is de-leveraging. Aggregate borrowing in the private sector is negative for the first time since the great depression. Saving is at an all time high. This is not because of the large deficit it is what the private sector wants to do (although the deficit certainly make it easier for the private sector to do what it wants)
So what will happen to that money that comes from the private sector repayment of debt and saving. I don’t think it is realistic to believe that the private sector will return to high borrowing and low saving.
So where will the money go? Are we looking at a shrinking economy (your prediction) or the formation of very high risk bubbles? The financial sector is going to have a lot of cash where will it go?
What is it “they” are expecting if they cut $150 billion/month in federal spending (even if for just a short while)
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roger erickson Reply:
July 25th, 2011 at 10:33 am
@jim,
> where will the money go?
Past responses were to use inflated financial assets to buy proportionally more real assets. That’s the whole point of a pump & dump scam.
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jim Reply:
July 25th, 2011 at 11:17 am
@roger erickson,
I can’t make any sense of that reply.
How does putting an end to federal deficit spending or just threatening to put an end to deficit spending (whatever this is) cause anybody to have inflated financial assets they can use to buy real assets.
And what does “past responses” mean? I see no comparable situation in the past.
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roger erickson Reply:
July 25th, 2011 at 4:58 pm
@jim,
You wont see anything if you don’t look. The answer is long, and more easily found in Warren’s “Mandatory Readings” link at the top of this page.
Where were you during TARP? Madoff? S&L Crisis? Invented War? Star Wars? Eisenhower’s Mil/Industrial Complex?
Created situations are always an extension of policy, which are always an extension of existing lobbying hierarchy.
If you don’t understand the dynamics of the SP-Mortgage crisis, try this:
http://www.benzinga.com/print/1796051
WARREN MOSLER Reply:
July 25th, 2011 at 11:08 am
they think the dollars are in the private sector to be spent if only the gov would stop borrowing them
the error is that when the spending stops the funds that were being borrowed aren’t there either.
so no private sector spending from that source materializes
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jim Reply:
July 25th, 2011 at 12:13 pm
@WARREN MOSLER,
they think the dollars are in the private sector to be spent if only the gov would stop borrowing them
_____________________________________________
In theory if the private sector starts borrowing and does it’s spending on credit as they did around 2006, then yes the spending will return without the federal deficit. But seriously nobody really expects that toothpaste can be put back in the tube.
There seems to be the jumbo elephant in the room that all sides are pretending doesn’t exist.
The private sector is determined to pay down debt and save. There is no evidence that anything will change that attitude for a good long while. That is the reality that everyone seems to avoid looking at.
____________________________________________
the error is that when the spending stops the funds that were being borrowed aren’t there either.
____________________________________________
That may be true in the long run. But in the short run there is all this money that is now funneling into the lending institutions in the form of savings and repayment of past debt. How is that money to reenter the economy if there are way too few who are credit worthy willing to borrow?
Here is a history of annual borrowing of the Non-govt sector of the economy:
http://tinyurl.com/4x9zcgu
Add to savings to what is being repaid and it clearly shows the money is there to be borrowed.
So who is going to borrow that excess if not the federal govt? Where is it going to go?
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WARREN MOSLER Reply:
July 25th, 2011 at 1:11 pm
and if the private sector was inclined to borrow and spend it would already be doing that. govt spending doesn’t make that more difficult, it makes it easier.
in any run there is no such thing as ‘money funneling into the lending institutions’ that then ‘reenters the economy’ etc.
loans create deposits, and only govt spending adds net financial assets. and govt borrowing and qe shift merely around those financial assets
ESM Reply:
July 25th, 2011 at 12:24 pm
@jim,
Jim,
An easier way to look at it is the following. Right now, the Treasury effectively spends by giving the private sector Treasury bonds, notes and bills in exchange for goods and services. The private sector isn’t being forced to give goods and services in exchange for Treasuries. It is doing so voluntarily. A failure to raise the debt ceiling would cut off this channel of spending, and only allow the government to spend with cash/dollars, which it could only get through increased taxation.
This wouldn’t necessarily be a bad thing, except that there is not enough aggregate demand to use up all of the economy’s capacity to produce goods and services as it is.
The demand generated by government only crowds out the private sector if there is no excess capacity.
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jim Reply:
July 25th, 2011 at 3:19 pm
@ESM,
Yes. Aggregate demand is down. But why is that?
The obvious answer is that the private sector borrowed far too much in the period from 1998 to 2008 and now the private sector is about the business of getting itself out of debt. In this chart the red is the private debt; the black is the federal debt; the blue is the total US credit market debt.
http://tinyurl.com/44bc98h
What that chart indicates is large sums of money are going into lending institutions to repay old debt. In aggregate there are no private loans today since loan repayment is much greater than loan creation. And yes i get that loans create deposits, but that is a rather worthless aphorism in a world where there are no loans.
The federal borrowing has thus far come close to offsetting the deleveraging in the private sector. But take away the federal debt and where do the loan repayments (and savings deposits) go?
Now I understand that in the long view the lower federal spending will mean less saving and less loan repayment will be possible. But in the short run where is that money going to be parked absent the federal govt there to be borrowing it?
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roger erickson Reply:
July 25th, 2011 at 5:06 pm
@jim,
Read Warren’s 7 Deadly Innocent Frauds above.
Financial assets get used up quick if an issuer isn’t supplying more – until the economy stops growing at all, that is. Absent renewed public currency creation, distributed growth is constrained to existing currency plus barter.
Private investors might have to work a bit harder to find better investment opportunities for purely financial assets.
July 25th, 2011 at 8:32 am
anybody explain the math logic of cutting spending by the same amount as the debt ceiling increase?
what’s the connection?
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John Zelnicker Reply:
July 25th, 2011 at 8:44 am
@anon, I don’t believe there is a connection. It is just a convenient measure for the Republicans to push for their main goal of shrinking the size of the federal government.
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anon Reply:
July 25th, 2011 at 8:59 am
@John Zelnicker,
yeah
its a pretty weird math connection though
wonder if there’s any explanation to it, or its just plain innumeracy and incompetence?
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anon Reply:
July 25th, 2011 at 9:00 am
@John Zelnicker,
i.e. a bit like saying:
yeah, we’ll let you increase the deficit, but for every dollar we allow you to increase the deficit, you have to reduce it by a dollar
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Dan Furlano Reply:
July 25th, 2011 at 9:13 am
@anon,
Isn’t that the logic? If you offset any increase with reductions you can present the case that you did no harm.
anon Reply:
July 25th, 2011 at 9:36 am
is that it – swapping deficit spending now for the same sized cut in spending later?
anon Reply:
July 25th, 2011 at 9:46 am
maybe I’m just slow, or missed something, but I don’t recall the GOP putting the argument quite this way
John Zelnicker Reply:
July 25th, 2011 at 9:46 am
@anon,
Yes, that seems to be what they are saying. Of course, I don’t expect future spending cuts to actually happen in the manner they will specify in the legislation. All the legislators have their pet projects and will defend them when it gets down to the nitty-gritty. My hope is that by pushing the cuts into the future there will be a chance to reduce the cuts that are made. Some of them are accounting gimmicks anyway and won’t actually reduce total government spending.
John Zelnicker Reply:
July 25th, 2011 at 9:49 am
@anon,
No, I haven’t seen that idea publicized, but I think a lot of people will look at it that way and think it makes sense.
Matt Franko Reply:
July 25th, 2011 at 11:35 am
@anon,
I think Wesbury here is probably a good proxy for the GOP thinking on this. He speaks to TP events.
http://www.ftportfolios.com/Commentary/EconomicResearch/2011/6/16/keynesians-are-completely-lost
He reviews some long term debt/gdp ratios going back to Reagan era, but seems like he misses the domestic effects on employment and output due to long term shifts in the external balance to high (or at least sig. higher) CA deficits.
I think this blindness to the CAD effects is the big “strategic blunder” they may be making, (if their position is not just pure partisanship). Resp,
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Matt Franko Reply:
July 25th, 2011 at 1:35 pm
@Matt Franko,
For instance no fiscal adjustments by the GOP (or Clinton) were ever made to address the trend shown in this graph (of interest is the data since 1980):
http://research.stlouisfed.org/fred2/series/NETFI
With no govt response, bye-bye middle class…. I still hear no one (except Warren/MMTers) advocating for a definitive response to this. Resp,
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Tom Hickey Reply:
July 25th, 2011 at 2:42 pm
@Matt Franko,
Maybe ending the middle class is part of the Plan?
Randy Wray, Shock Doctrine and the Debt Limit at EconoMonitor. Randy is on a tear over there.
rvm Reply:
July 25th, 2011 at 4:05 pm
@Tom Hickey,
Thank you for the link again!
July 25th, 2011 at 3:25 pm
what happens technically during a default?
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luigi Reply:
July 26th, 2011 at 9:14 am
@luigi,
http://www.nakedcapitalism.com/2011/07/so-what-might-happen-if-we-get-to-august-3-with-no-deficit-deal.html
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July 25th, 2011 at 3:56 pm
Amazing amount of nonsense here:
http://krugman.blogs.nytimes.com/2011/07/25/default-in-a-liquidity-trap-very-wonkish/
… as a reply to Nick Rowe’s
http://worthwhile.typepad.com/worthwhile_canadian_initi/2011/07/do-keynesians-believe-their-own-models.html
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Tom Hickey Reply:
July 25th, 2011 at 6:00 pm
@Ramanan,
They deserve each other. :)
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Ramanan Reply:
July 26th, 2011 at 2:58 am
@Tom Hickey,
Yes.
Krugman: “I think this is wrong — but in an interesting way.” on Nick Rowe’s crack at the problem.
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Matt Franko Reply:
July 25th, 2011 at 7:03 pm
@Ramanan,
K: “This makes short-term debt worse than cash, unless it offers a sufficiently positive interest rate. Yet we’ve just posited that the Fed is ready to buy bonds to keep the rate at zero. So what happens? In a simple model, investors sell *all* short-term US debt to the Fed.”
If the 4-week UST rate went significantly above the current 0.25% policy IOR rate, would the Fed even care, wrt Monetary Policy? I dont view the Fed’s responsibilities wrt Monetary Policy as being required to set the short term Treasury rates? Resp,
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Ramanan Reply:
July 26th, 2011 at 3:13 am
@Matt Franko,
Donno – normally it controls the short term rates and the T-bills rates adjust automatically but here one is talking of some scenarios where we enter uncharted territory. strange to compare it with “inflation expectations” – strange people.
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anon Reply:
July 25th, 2011 at 9:52 pm
@Ramanan,
“Andy: hang on. I’ve just had a thought!”
Nick Rowe
:)
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Ramanan Reply:
July 26th, 2011 at 2:52 am
@anon,
“What happens?
Any good economics student who has completed intermediate macro and really understood the material and has the capacity to think (rather than just memorise results for the exam) ought to be able to take a decent crack at this question.”
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beowulf Reply:
July 25th, 2011 at 10:40 pm
@Ramanan,
Nick has the superior beard.
Reply
Ramanan Reply:
July 26th, 2011 at 2:55 am
@beowulf,
superior beard .. :)
Reply
July 26th, 2011 at 2:25 am
[...] that as my friend Warren Mosler insists, he is dead wrong, and therefore we are all dead [...]
July 26th, 2011 at 11:06 am
[...] Obama believes, it will all come back that much stronger. Except, that as my friend Warren Mosler insists, he is dead wrong, and therefore we are all dead ducks. As Warren notes, have you ever heard [...]