Tuesday, July 26, 2011

Why I'm worried

I want to be very clear about exactly what kind of alarm I'm raising. We are not headed inexorably towards global economic catastrophe. We are heading for a global catastrophe if Congress does not raise the debt ceiling before August 2 (or thereabouts -- there is some disagreement over the exact timing, but it doesn't matter. We actually will reach the point of no return earlier than that.) So avoiding catastrophe (for the time being) is very simple: raise the debt ceiling. That's it.

Normally this would not be an issue at all. The debt ceiling has been raised 90 or so times since it was first created back in WWI. What's different this time is that we have an opposition party in Congress that is determined to see to it that Obama is a one-term president by any means necessary. Against this we have a president who looks back as a role model on Bill Clinton successfully standing up to Newt Gingrich in the mid-90's. And we have a ticking clock. That is a very dangerous combination.

The other difference this time is that the stakes are much, much higher. Shutting down the U.S. government is a colossal pain in the ass, but ultimately not a long-term problem. Defaulting on the debt, which will happen if the debt ceiling isn't raised, will be vastly worse. It will be be the worst thing that has happened to the world economy since WWII, and possibly the worst in living memory. No one knows. But since WWII, all of the mathematical models that underpin the world's economy are based on the assumption that the U.S. will not default on its debt. If that assumption is discharged, all bets are off. No one knows exactly what will happen, but whatever it is it will not be good for most people. There will be runs on banks, unemployment, foreclosures, that will make 2008 look like the good old days.

I still believe that Washington will ultimately come through and figure this out. But the clock is ticking, and right now things are not looking good. The chances of a worst-case scenario are low, but they are not zero. And the more time goes by the higher the probability becomes, until at some point we will reach a tipping point and by then it will be too late.

Exactly where that tipping point will be is also impossible to determine. Frankly, I'm surprised the markets have not reacted more negatively to the situation. There are two possibilities: either someone out there knows something I don't, or the world is being complacent. There is ample precedent for complacency. Ironically, it is the firm belief that nothing bad will happen that could ultimately prove to be one of the major contributing factors to something bad actually happening. That is why I am sounding this alarm. It's not because I want to be a doom sayer, it's because I'm hoping that if enough people get scared enough and start making enough noise that that will contribute to solving the problem, at least in the short term.

[UPDATE:] For a contrary view, read this. And for a counter-contrary view, see this.


Don Geddis said...

It seems that there are two separate issues. The first is whether the Republicans and Democrats/Obama can actually come to some compromise agreement about the debt ceiling prior to Aug 2. I think you are right, that there is some non-zero chance that they will fail to beat the deadline.

A second question is, if the US defaults on its debt, and actually fails to make promised interest payments, what consequence would that have for the US (and global) economy? Again, I think you are correct that it would be an economic catastrophe.

But the tiny bit of wiggle room is: even if the agreement fails (issue #1), it does not necessarily follow that the US will fail to make interest payments (issue #2). The 14th amendment, the platinum coin seignorage, some deal between the Fed and the Treasury, or perhaps just prioritizing government payments to cut off other expenses before interest payments ... there are lots of creative options.

All these options are far worse than pretty much any Congressional agreement. But they are far better than actual, literal, default on promised interest payments.

If worst comes to worst (no agreement), it is highly likely that Obama would pick one of these other second-best choices, rather than literally fail to make required interest payments.

The US is not going into default.

Ron said...

I hope you're right.

John Dougan said...

An interesting perspective on the technical aspects of what is happening in DC;