Most countries – Ireland included – do all they can to avoid defaulting on their debt.
merica though is different and every few years some Republican lawmakers embrace the idea that the threat of default offers a cathartic moment to ‘drain the swamp’, break what they see as Washington’s addiction to spending and to shrink the government.
They get this opportunity because spending and tax is voted separately and earlier than the debt approval. That time has come again and with America’s gross debt now standing at a record $31.4trn (€28.8trn) another standoff looms.
Yet even amid the hyper-partisan language of 2023, the working assumption among investors and credit rating agencies is that we have seen this movie before and we know how it ends – when push comes to shove and the US Treasury faces a choice between paying bondholders or soldiers, a deal will be done.
This is what happened in the acrimonious standoff in 2011 when there was a deal just hours before the deadline, and again in 2013. Even in 2015, when I was working in Washington as a journalist, a relatively amicable settlement still went into overtime before it was resolved.
That benign assumption however is probably the biggest risk to the world economy – just as the American consumer is the engine of global growth, it is US Treasuries that power the financial system.
The problem in 2023 is bigger than 2011. Given the tiny Republican House majority – Speaker Kevin McCarthy’s job as speaker hangs on just four votes – the legislator who shouts loudest and holds out longest will end up wielding the most power and there’s good reason to believe that the likes of Representative Marjorie Taylor Greene – a Trump ally and sometime QAnon conspiracy theorist who became a member of Congress in 2021 – may have very little to lose from holding out right until the end.
The legislator who shouts loudest and holds out longest will end up wielding the most power
Ms Greene, an ally of Mr McCarthy, says “there’s gotta be cuts in spending” in exchange for an increase in the debt limit. She hasn’t done the maths or “really formulated an exact list”, but still.
Others among the Freedom Caucus lawmakers grouping of which she is a member, say they have a deal with the House Republican leadership to present a budget that balances over 10 years and to freeze discretionary spending at 2022 levels.
This isn’t happening anywhere outside the fevered brains of the caucus. An analysis by the bipartisan Committee for a Responsible Federal Budget calculates that to get to that balanced budget, all spending would need to be cut by a quarter. If you exclude defence, a Republican favourite, from this along with social security and Medicare then the remaining spending would need to be cut by 85pc.
If the Republican lawmakers who forced Speaker McCarthy to jump through 15 rounds of voting are in no mood for compromise, then neither is the administration of President Joe Biden. Many Democrats believe Barack Obama made too many concessions in 2011 and that retarded the economic recovery and hit their electoral chances. That deal resulted in the sequestration budget cuts that automatically capped defence and non-defence discretionary spending – ie everyone lost.
“Odds that lawmakers blunder either out of intent or ineptness are uncomfortably high,” Mark Zandi, chief economist at credit rating agency Moody’s, warned. This came after US Treasury Secretary Janet Yellen said the government had implemented extraordinary measures to keep on spending and delay the X-date, which is Treasury’s name for the day when the US can’t meet its obligations in full and some payments have to be prioritised over others.
Ms Yellen says that date could come as soon as June, although many economists say things could keep going through to August. That long timeline, of course, relieves the pressure for any meaningful discussions in Congress.
We know that the US Treasury had a plan to prioritise debt and interest over other payments in 2011 to stave off a default, thanks to the release of Federal Reserve documents. We – and financial markets – have also learned that the brinksmanship of 2011 did not end up in default and so when it came to 2013, the reaction in bond markets was less severe. Given that Ms Yellen was at the Federal Reserve in 2011, we can also be sure she is familiar with the devices Treasury can use.
A study by Fed economists found that bond yields across all maturities were four to eight basis points higher than they otherwise would have been just prior to the projected breach dates during the 2011 and 2013 episodes, but fell sharply when they were resolved.
The brinksmanship of the 2011 standoff did cost America its triple-A credit rating from Standard & Poor’s
“Furthermore, the eleventh-hour resolution in 2011 may have indicated to market participants that even if there were a debt limit breach, in all likelihood it would be resolved quickly. In other words, the 2011 episode taught participants that the likelihood of a catastrophic event following a technical default was lower than previously perceived,” the March 2017 Fed analysis concluded.
The brinksmanship of the 2011 standoff did however cost America its triple-A credit rating from Standard & Poor’s. At the time, S&P said “the downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges to a degree more than we envisioned”.
It would be hard to argue the political institutions have recovered. Oxford Economics estimates that if there isn’t a deal to balance spending and revenue in the third quarter, there would have to be spending cuts of $260bn. That, the consultancy calculates, would result in real gross domestic product falling by 6pc on an annualised basis.
We have seen how financial markets reacted to Britain’s budget blunder last year. That was a storm in a teacup.
Perhaps there will be another compromise. After all, the debt ceiling has existed in one form or another since 1917, but there are better ways to run the world’s largest economy and ino one would use the words stable and predictable about today’s US policymaking and institutions.