Today, we present a guest post written by Jeffrey Frankel, Harpel Professor at Harvard’s Kennedy School of Government, and formerly a member of the White House Council of Economic Advisers. A shorter version appeared at Project Syndicate and LA Times.
January 22, 2023 — The US federal debt hit its legal limit, $31.4 trillion, on Thursday, January 19, 2023. Everyone feels that they have seen this movie before: there is no need for alarm because the politicians will fix things at the last moment. But this time, the movie could well end tragically, as a result of the intransigence of Republicans in Congress. It is likely that they will refuse to raise the debt ceiling until after they have driven the car over the cliff. This could mean a once unthinkable default by the US government. Unfortunately, letting them do that may be the best strategy available to President Joe Biden when the time comes.
In the 1955 movie Rebel Without a Cause, James Dean survives a fatal game of “chicken,” jumping out of his car at the last moment, while his rival miscalculates and drives off a California cliff. Miscalculation is what makes a game of chicken so dangerous.
We still have at least five months to go before the government comes to the true edge of the cliff. Treasury Secretary Janet Yellen said in a January 13 letter to the new Speaker of the House that she will now pursue the set of “extraordinary measures” that have unfortunately become ordinary in recent decades, and will thereby postpone the day of reckoning at least until early June.
We must remember that a decision to raise the debt limit is not a decision to spend money. It is rather, a decision by the government to honor the bills that it already owes, as a result of spending and tax decisions that Congress has enacted in the past. If Congress wants to reduce the budget deficit — a worthy aim — it should find spending to cut, taxes to raise, or both.
- Creative responses
How should the Administration respond, under the all-too-likely scenario in which the Congress still refuses to back down when Treasury default is imminent? Washington is seeing the revival of several possible untested strategies that have been proposed in similar debt stand-offs in the past, particularly 1995-96, 2011, and 2013.
First, the President could invoke the 14th amendment, which was passed in the immediate aftermath of the Civil War (ratified in 1868). The relevant clause provides that the “validity of the public debt of the United States, authorized by law, …, shall not be questioned.” The point is that Congress has passed laws that contradict each other – the debt limit versus the spending and tax bills enacted in the preceding budget. (The budget these days entails a deficit in excess of $1.0 trillion, which automatically implies an annual increase in the federal debt of that amount.) The argument is that the executive branch, forced to choose between conflicting laws, should opt to fulfill its financial obligations, citing the 14th amendment, and let the courts eventually rule on the legality. The counter-arguments are that Biden’s opponents would accuse him of flouting the law [the debt limit] in his zeal for federal spending, that the confrontation would amount to a constitutional crisis, and that it is uncertain how the Supreme Court would ultimately rule.
The most outlandish-sounding of the possible strategies is to mint a trillion-dollar platinum coin, which the Treasury has the legal power to do. The Treasury would then deposit the coin into its account at the Federal Reserve. In essence, the Fed Reserve would buy the coin in exchange for conventional money, which the Treasury would in turn use to pay its bills. The argument in favor is that, as crazy as it sounds, it could actually work. The counter-arguments are that its legality is untested; that it might compromise the independence of the Fed, and that it sounds especially gimmicky. It would feed paranoia regarding money creation, a topic around which conspiracy theories clustered even long before the on-line misinformation of the Trump era.
The Treasury has enough money coming in on a regular basis, through tax collection, that it could probably continue to meet at least 80%-83% of its already-legislated outlays without further borrowing. But which 80%? Some have suggested prioritizing interest payments to bond holders, with the aim of avoiding a default on the debt and its attendant penalties — a rating downgrade and a need to pay higher interest rates on all future borrowing. One disadvantage is that — even if bond holders continued to be paid on-time — failing to pay in a timely manner money owed, for example, to office supply firms, construction contractors, and for that matter government workers — would still be seen as dodging legal obligations.
Another disadvantage is that, as a matter of arithmetic, to keep paying creditors the government would have to cut politically sensitive big-ticket budget items such as payments to social security recipients, or Medicare patients, or members of the armed forces. Biden’s political opponents would then accuse him of deliberately cutting the payments that are most politically sensitive, just to stir up popular anger.
The Treasury has said that it could not prioritize payments even if it wanted to, because its computer systems and administrative apparatus are not set up that way. Who gets paid first evidently depends largely on which bills come in first.
Notwithstanding such administrative constraints, some House members are currently trying to develop plans for giving priority to interest payments, mandatory spending (such as Social Security, Medicare, and veterans’ benefits), and military discretionary spending (such as soldiers’ salaries).
But the most telling flaw in the proposal is that the three categories add up to a huge share of total federal spending, about 85% [= interest payments equal to 8% of spending and rising fast, plus mandatory spending at 63%, plus military spending at 14%]. There would not be enough incoming revenue to pay for them all. Imagine for a moment that diehard fiscal hawks seriously wanted to zero-out all the rest — all non-military discretionary spending — including even the budgets of acutely necessary and visible agencies such as the FAA (which keeps the planes flying), and the Food Safety Inspection Service (which keeps meat safe to eat). Even that drastic hypothetical step would not be enough to close the gap between spending and revenue, without also cutting one of the three protected categories.
- What should Biden do?
Are the drawbacks of the gimmick responses outweighed by the drawbacks of defaulting on government obligations? Ten years ago, one might have said “yes,” that the consequences of a default would be so disastrous that it would be worth the political embarrassment of trying the trillion-dollar coin or 14th amendment strategy.
The 2011 debt standoff prompted S & P to downgrade the US credit rating for the first time in history and adversely affected the interest rate that the Treasury had to pay on subsequent borrowing. But some of the fire-breathing newly elected members of Congress may lack the historical memory to look back or the foresight to look ahead.
The creative solutions, even if technically workable, would be perceived as gimmicky, would obscure who was to blame, and would not prevent global financial markets from starting to doubt the reliability of the US government’s commitment to fulfill its obligations. Ultimately, the Republicans will have to back down. Because these “rebels without a cause” are even more bloody-minded this time around, the stand-off will probably go down to the wire and the government this summer may be forced to shirk some obligations for a few days, or even weeks. Then, crashing securities markets, screaming beneficiaries, and shifting voter attitudes would finally persuade enough hold-outs to raise the debt ceiling. Ideally, Congress at some point would also abolish altogether the need to vote regularly on whether to honor the obligations it has already legislated.
This post written by Jeffrey Frankel.
I like that 14th Amendment discussion. Of course the Republicans would immediately run to the Supreme Court.
I also like this: “The most outlandish-sounding of the possible strategies is to mint a trillion-dollar platinum coin, which the Treasury has the legal power to do.”
I get the issues here but why does this tempt me to find the relevant Dr. Evil clips. Oh wait – we are not suppose to link to Youtube clips.
I always wondered why we change this silly nominal debt limitation to a limitation on the debt/GDP ratio maybe putting that at 125%. Heather Hennerich’s ‘Debt-to-GDP Ratio: How High Is Too High? It Depends’ provides some useful thoughts.
FRED Blog also notes this interesting point:
The many ways to calculate how much the U.S. federal government owes
nice use of % of gdp.
look like federal debt not held by the public is 30% or so gdp.
a couple of hours reading the annual audit of the bureau of fed debt would be clarifying,
but not having anything to do with playing chicken with mccarthy
Another clown show ala Rudy Giuliani:
Rudy Giuliani, a personal attorney for former President Donald Trump, said he is suffering a “tremendous burden” because he couldn’t stop President Joe Biden from being elected. Rudy Giuliani, a personal attorney for former President Donald Trump. On his Sunday radio show, Giuliani complained that Biden does not “know what he’s doing.” “I don’t want a senile president, and I don’t want a corrupt president,” co-host Dr. Maria Ryan said. “Well, the American people voted for him,” Giuliani replied. “They knew he was corrupt or at least half of them knew he was corrupt. I wasn’t able to get the message to the other half.”
Poor Rudy – such a burden? Biden is not senile but RUDY clearly is. And we had a corrupt President from 2017 to 2020 but not since. But Rudy’s real burden will be when this criminal ends up in jail. Poor little Rudy!
How demented can Trump get?
Former President Donald Trump attempted to use the recent Atlanta protest and the Monterey Park, California, mass shooting to defend January 6 rioters, despite the latter seemingly having no connection or resemblance to the Capitol attack. Trump made the comment on Sunday morning on his social media platform, Truth Social. In it, he says that the perpetrators of both events will not be punished and proceeded to rail against January 6, 2021, riot participants having “their lives ruined,” while seemingly promising again to pardon them should he be reelected in 2024. “[Ten] dead in California shooting, horrible gun wielding ANTIFA protest against our great police in Atlanta – Nothing will happen to them despite night of rage and destruction,” Trump’s post read. “Yet our January 6th protestors, over a Rigged Election, have had their lives ruined despite nobody killed except true Patriot Ashli B. This situation will be fully rectified after 2024 Election. Thank you!”
The Atlanta protest that Trump referred to occurred on Saturday, with participants gathering to protest the recent police killing of activist Manuel Esteban Paez Terán on Wednesday. Terán, 26, had gotten into a verbal altercation with officers near the planned sight of a massive police training facility, colloquially known as “Cop City.”
The California mass shooting Trump mentioned took place at a dance studio in the Monterey Park suburb of Los Angeles, near an event for the Chinese Lunar New Year. A gunman, who remains at large and unidentified, opened fire into the studio, killing 10 and leaving more critically injured. The U.S. Census Bureau’s data reports that 65 percent of Monterey Park residents identify as Asian American. “Our hearts go out to those who lost loved ones tonight in our neighboring city, Monterey Park, where a mass shooting just occurred,” Kenneth Mejia, Los Angeles’ city controller, said in a statement. “Monterey Park is home to one of the largest Asian communities in Los Angeles County and many were out celebrating the Lunar New Year.”
《It would feed paranoia regarding money creation, a topic around which conspiracy theories clustered even long before the on-line misinformation of the Trump era.》
Is the Quantity Theory of Money the canonical misinformational conspiracy theory?
Why do you yanks have a debt ceiling?
and why are my comments always in moderation?
Once upon a time, each U.S. spending bill had its own borrowing authority. That was at a time when the government was new and roads and frigates were scarce.
The need to legislate bond issuance for each spending bill became onerous as government became more complex. Some smart legislators though “Why don’t we lump all the bond authorization together and save work?” The debt ceiling was born.
The debt ceiling was not devised to limit the debt, but to ease the legislative burden of managing it. That intention has been corrupted by politics.
Frankel is right in his assessment, as usual. Of, course, if revenues fall short of forecast, then we have less time to raise the debt ceiling before default will occur. Revenues fell in Q4, not all that common in a growing economy. As an examp!e of how much uncertainty there is in these Treasury borrowing estimates, between August and October of 2022, Treasury’s Q4 borrowing estimate was increased by $150 billion. That is part of the context in which the debt ceiling “game of chicken” takes place.
I have one rhetorical quibble with Frankel, having to do with this:
“…failing to pay in a timely manner money owed…would still be seen as dodging legal obligations.”
“Seen as”? True, but squishy. “Obligation”? True, but also squishy. “Failing to pay in a timely manner” is an actual default. More than a “technical default”, more than “seen as dodging an obligation”, failure to pay any obligation on time is default, by definition.
At least since the days of Gingrich saying a “technical default” would be good for the country, the right has been employing weasel-words to suggest that missing payments is something other than default on financial obligation. The right has succeeded to the extent that weasel-words are now part of our discussion of government default.
Failure to pay on time is default. Any such failure is likely to be “seen as” default by ratings agencies and holders of Treasury debt.
Nope, because your revenue error was the bubble bursting…..but yry financial revenue will grow now. People still don’t get it or the pandemic bubble.
You simply don’t know enough to make such claims. You rarely miss an opportunity to pretend, though.
There are currently talks about changing the debt ceiling to be a % of GDP with automatic spending cuts if it is breached (without congress approving). It may not be a bad way of constraining spending but it fails to recognize that the deficit is a mixture of failed restraint on spending and failed increases in tax income. Sure make the breach of a set % of GDP set in automatic 5% cuts in military and other discretionary spendings – but also make it automatically increase the top 3 income tax brackets with 0.5, 1.0 and 1.5% and make a minimum tax on corporations of 1%, 2% and 3% of sales in excess of 5 million, 50 million and 500 million. Those reduced spending and increased tax revenues would be tapered down when the debt falls below its % of GDP ceiling or congress increased that ceiling to fit their approved spending.
rather play chicken with McCarthy on debt, than Putin on nuclear war.
Executive order can abolish it as well. Ignore the courts. Nullify their treason.
Dean Baker weighs in:
Like all good Keynesian economists, I’m a big fan of the platinum coin. The law explicitly allows the Treasury to print platinum coins in any denomination. That means it absolutely could deal with the debt ceiling by printing a platinum coin denominated for $1 trillion and selling it to the Fed.
This would not count as debt for debt ceiling purposes. The government would have sold an asset, the coin, in exchange for $1 trillion that it could then use to meet its bills. From an accounting standpoint, it would be the same thing as selling off blocs of government land for $1 trillion.
Unfortunately, the Biden administration seems reluctant to go the coin route, at least for now. But there is a slightly less gimmicky way for the Treasury to buy some room on the debt ceiling.
In 2020 and 2021 the Treasury issued trillions of dollars of debt at very low interest rates. Much of this was longer term debt, with maturities of 10 or even 30 years. Since interest rates are now much higher (the interest rate on 10-year Treasury bonds is now near 3.5 percent), the bonds issued at low interest rates in 2020 and 2021 would sell for much lower prices in the market today.
This might mean, for example, that a $1,000 10-year Treasury bond, issued at an interest rate of less than 1.0 percent in the summer of 2020, would sell for just $850 in the market today. For purposes of the debt ceiling, the law calculates debt at its face value, rather than its market value.
This means that Treasury could buy this bond for $850, and thereby reduce the value of outstanding debt by $150. With trillions of dollars of debt now selling for prices that are lower, and in some cases substantially lower, than their face value, the Treasury can reduce the amount of outstanding debt by hundreds of billions of dollars simply by buying up this debt at the current market price.
This will not end the standoff, we are running large deficits and eventually the Treasury will run out of bonds to buy, but this move could allow President Biden to delay the standoff over the debt ceiling for many months. (Maybe he’ll get out the coin at that point.)
As policy, this is of course absurd. The government has better things to do than to play around shuffling Treasury bonds. But the debt ceiling is also absurd. So, like the coin, it is an absurd solution to an absurd problem.
This sort of scheming on manipulating the measured size of the debt is not new, some of us have played with it for a long time. But absurd standoffs on the debt are also not new, so it’s always good to remember our stock of off-the-shelf fixes.