May 16, 2011

A DANGEROUS argument about the debt ceiling is gaining currency just as the country hits the legal borrowing limit: It’s no big deal.

This position takes several forms, all wrong: It’s no big deal because the date keeps getting pushed off. Yes, the official panic date is now Aug. 2, later than previously thought, but further postponements can’t be counted on. The date is calculated by career employees at the Treasury Department. It’s no big deal because the government can sell off assets — all that gold! — to cushion the impact. Yes, but that would be stupid because the revenue would be at fire-sale prices, the tactic has obvious limits and the implications for U.S. creditworthiness would be alarming. The problem is not the amount of debt the United States has outstanding, it’s the growth trajectory of that debt. It’s no big deal because the country would not have to default on its debt obligations — it could pay bondholders but put off paying other obligations. Yes — such as Social Security checks and soldiers’ salaries? Failing to pay its obligations, as Treasury Secretary Timothy Geithner noted in a letter last week to Sen. Michael Bennet (D-Colo.), would represent “a massive and abrupt reduction in federal outlays and aggregate demand. This abrupt contraction would likely push us into a double dip recession.”

Finally, It’s no big deal because the alternative of failing to get the debt under control is even worse. This alluring argument made an appearance on the Wall Street Journal’s Saturday op-ed page, in an interview with investor Stanley Druckenmiller. Mr. Druckenmiller made the case in support of House Speaker John A. Boehner’s argument that “it’s true that allowing America to default would be irresponsible. But it would be more irresponsible to raise the debt ceiling without simultaneously taking dramatic steps to reduce spending and reform the budget process.”

The Ohio Republican is correct, Mr. Druckenmiller argued, because bondholders are sophisticated enough to understand that a brief delay in receiving their interest payments is worth the certainty of knowing that the United States has put itself on a path to sustain those payments in the future.

And what if markets aren’t quite so sanguine when confronted by the political system’s failure to avert default? “My guess is that the bond market would rally as long as it believed the ultimate outcome was going to be genuine entitlement reform — that we wouldn’t even have to find out about a meltdown because it wouldn’t happen,” Mr. Druckenmiller said.

Except that it might not work out quite so happily. As Mr. Geithner wrote, “default on Treasury debt could lead to concerns about the solvency of the investment funds and financial institutions that hold Treasury securities in their portfolios, which could cause a run on money market mutual funds and the broader financial system — similar to what happened in the wake of the collapse of Lehman Brothers. As the recent financial crisis demonstrated, a severe and sudden blow to confidence in the financial markets can spark a panic that threatens the health of our entire global economy and the jobs of millions of Americans.” Perhaps Mr. Druckenmiller’s rosier scenario is correct, but that’s an awfully risky bet.

Getting the debt under control is crucial to the nation’s future, and the debt ceiling vote could serve as a useful catalyst for doing so. But there is a thin line between employing the debt ceiling as an opportunity and heedless games of brinkmanship. No one should wish to gamble on an American default.