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.