October 15, 2013 7:19 pm

The debt-ceiling doomsday device

The ceiling is so dangerous because Obama could not obey it in a non-destructive way

Some laws are too dangerous to be allowed to remain on the books. Take, for example, the US debt ceiling. It is the legislative equivalent of a nuclear bomb aimed by the US at itself, with the rest of the world within its blast radius. What must never be used should not exist. Regardless of the outcome of the current negotiations, the law needs to be repealed. Orderly government cannot be pursued under so destructive a threat. It is quite different from a partial government shutdown. Albeit foolish and unjust, that is just about manageable. Failure to lift the debt ceiling is not.

The imbroglio over the ceiling does have a darkly amusing side. Many will recall Republican insistence that “uncertainty” was thwarting economic recovery. Yet it is difficult to imagine policies better designed to create maximum uncertainty than a possible default by the world’s most important debtor. Asked about the consequences of a failure to reach a deal on the ceiling, Jamie Dimon, chief executive of JPMorgan Chase, responded: “You don’t want to know.” But we must seek to know; the results would be calamitous.

Why is the debt ceiling too dangerous to use? This question has two answers.

The first is constitutional. In a recent article, Neil Buchanan of The George Washington University and Michael Dorf of Cornell argue that a binding debt ceiling would create a “trilemma” for the president: “Ignore the debt ceiling and unilaterally issue new bonds, thus usurping Congress’s borrowing power; unilaterally raise taxes, thus usurping Congress’s taxing power; or unilaterally cut spending, thus usurping Congress’s spending power.” Thus, a binding debt ceiling would force the president to violate his obligation to “take care that the laws be faithfully executed”. The authors conclude that the president should choose the “least unconstitutional” course and ignore the debt ceiling. But, inevitably, whatever the president did would create a constitutional crisis. No responsible Congress would seek to put the president in that position.

The second reason why the debt ceiling is so dangerous is that the administration could not obey it in a non-destructive way. At some point between October 17 and the end of the month, the administration would lack the money to pay its bills. All choices would be dire.

One much discussed choice is “prioritisation”: the federal government would pay “high priority” claimants, such as the Chinese government, and default to “low priority” claimants, such as beneficiaries of Social Security or Medicare. Yes, the idea is that awful.

The US Treasury has two potent objections. First, prioritisation would not protect the “full faith and credit of the United States” – it would still be a default. Second, the US government’s computer systems do not allow it to choose among the close to 100m payments it makes a month. But Fedwire, the system that handles sovereign debt payments, is distinct from the systems making payments to government agencies and other vendors. So maybe the US Treasury could pay the former obligations first and then use any remaining money for the latter, a possibility it denies even exists, to preserve its bargaining credibility.

Even if possible, which is unclear, the politics of prioritisation would be disastrous. Yet the economics of a failure to service debt would be worse. US Treasuries are the world’s most important safe assets. If they were to default, even temporarily, there would be an immediate impact on risk premiums and a quite possibly permanent impact on their role as havens. Haircuts would be imposed on their use as collateral. The result, as my colleague Gillian Tett has noted, might be a huge disruption to market liquidity and credit across the world. A Lehman default is one thing; a US default would be quite another. No wonder the gathering of central bankers and finance ministers in Washington last week for the International Monetary Fund/World Bank annual meetings was so agitated about the issue.

The less economically damaging alternative would seem to be for the US government to default on its non-debt obligations. Indeed, many in the Tea Party believe the ceiling is a way to impose a balanced budget, though one that would curtail even the short-term borrowing normal for households. Today, this would require immediate elimination of a deficit of about 4.2 per cent of gross domestic product. An instantaneous cut of this magnitude would lower GDP by far more than the 6 per cent that conventional multipliers might suggest. The reason is that all built-in stabilisers would be cut off. As revenue fell along with GDP, spending would automatically shrink further. GDP could fall 10 per cent. This would inflict a domestic and global disaster.

Thus, if the administration were to obey the debt ceiling, it would have a choice between a debt calamity and an output disaster. Yet Barack Obama is also right that he cannot concede to people wielding this threat because that would increase their incentive to use it and so, in the long run, the likelihood that the bomb would explode. This device needs to be disarmed. Alas, that is not going to happen.

So the administration also needs to decide what it would do if the ceiling were not to be lifted in time – be it now, next month or at a later date. The least bad answer would be: keep borrowing. The president cannot state he would do so, before the fact. Indeed, he must deny it, since knowing this would lower his opponents’ incentive to raise the ceiling. Yet, if it came to the worst, he would have to borrow, invoking the need to preserve the credit of the government, without which it would be permanently damaged.

Borrowing under a constitutional cloud would be risky. The simplest way to minimise these risks would be to borrow short-term. After all, the US Federal Reserve must ensure that the interest rate remains zero, in order to preserve its monetary policy. The House of Representatives might impeach the president for the “high crime” of ensuring the US government fulfils its promises, but this would fail in the Senate. Someone might challenge Mr Obama’s decisions in court. But how could a judge conclude that the president acted unconstitutionally if Congress has given contradictory instructions?

It is insane that such a discussion is even possible. Abolish the ceiling now. It is an invitation to mischief.

martin.wolf@ft.com

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Letter in response to this article:

A Moore’s law for public expenditure / From Mr Anthony Smouha

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