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Debt ceiling update: ‘Prioritization’ is Republican for default

Source: Goldman Sachs Research

Here we go again.

The excitement never stops here in D.C. these days. Biden’s out, Ryan’s not quite in, and as all this mishegoss transpires, each day brings us closer to the debt limit.

What’s the debt limit? It’s the total amount of money that Congress authorizes the Treasury to borrow to fund the obligations of the federal government.

Let’s be extremely clear about this. Congress, not the president, sets the levels of spending and taxes. (The president may propose a budget, but Congress has to pass it for it to become law.) If Congress fails to appropriate the funds needed to run the government, the government shuts down until they agree on a spending plan. (Note: A government shutdown is different from a debt ceiling crisis; c’mon, people, learn your dysfunctions!) In most years, the amount they agree to spend surpasses the amount of revenues they agree to collect. The difference must be made up by borrowing. But if Congress fails to raise the borrowing authority (i.e., the debt limit), the government will eventually default on its spending obligations.

As regards the politics of the debt ceiling debate, these are critical points. Raising the debt limit does not appropriate or authorize a penny of new spending. Raising the debt limit does not increase spending by one penny. All that raising the debt ceiling does is allow the government to borrow in order to meet the spending obligations that Congress agreed to.

There are those who think raising the debt limit raises spending; therefore, they wrongly reason, refusing to increase the borrowing limit will reduce spending. This is akin to believing that not paying for the meal you just ate will help you lose weight.

If congressional conservatives fail to increase the limit, the government would lack the cash on hand to fully meet its myriad financial obligations, which include interest payments to government bond holders, tax refunds, payments to Medicare doctors and hospitals, veterans, active duty troops, private contractors, Social Security recipients and many others. The Treasury makes around 80 million separate payments per month.

Why have a debt ceiling, then, if we’re just going to have to continuously raise it? That’s a good question, as it’s really a historical relic that’s been around for about a century and, until manufacturing crises became Congress’s national pastime, was routinely raised without any sort of partisan ruckus. Since 1960, it’s been raised or extended 78 times, 49 times under Republican presidents and 29 times under Democrats. Reagan raised the damn thing 18 times; it went up nine times under George H.W. Bush, seven times under his son and seven times so far under Obama.

The general consensus among those paying attention to this sorry spectacle is that we won’t default. Once the obstructionists finish putting on their show for the folks back home, the grownups will raise or extend the limit.

But recent economic research has shown that even flirting with default has negative impacts on consumer confidence, business optimism, stock market prices and volatility, and more expensively, Treasury yields. When debt purchasers get slightly spooked by these default threats, they bump up risk premiums by a few basis points (hundredths of a percent). No question, interest rates on government debt have been extremely low, but even a tiny increase can still lead to billions more in interest payments.

The figure above shows yields on short-term Treasury issuances with days to the Treasury’s deadline on the X-axis. The deadline this time around is Nov. 3, when Treasury has $30 billion of cash on hand to make payments. Sounds like a lot, right? Well, they face a payment of about $40 billion on Nov. 3.

Anyway, the figure above shows that even while most of us believe we won’t breach the ceiling, the nervousness generated by the debate bumps up short-term yields. And yes, that has the opposite impact that these supposedly fiscally hawkish posers say they want: it slightly worsens our fiscal outlook by increasing the government’s debt burden.

In order to purportedly avoid these outcomes, some House Republicans have pushed this idea of “debt prioritization,” meaning they’ll allow the Treasury to borrow only enough to pay for certain obligations but not others, say for Social Security and interest payments but not any of those other debts noted above.

This idea may work in the fantasy land of Capitol Hill economics, but in the real world, borrowers don’t get to choose which obligations they meet and which ones they default on. Paying some debts and not others avoids neither default nor the economic consequences noted above. Investors seeking higher risk premiums would not be assuaged if Social Security payments are made but Medicare payments are not. As budget analyst Joel Friedman put it, “By appearing to make a default legitimate and manageable, [prioritization] would heighten the risk that one will actually occur.”

In other words, prioritization is just Republican for default.

End of the day, I find it almost unimaginable that we’ll let the hard right drive us into this abyss. But the fact that we’re even arguing about it is a small victory for those for whom government dysfunction is a means to an end. These are the representatives who signal to their constituents: “Washington is broken. Send me there and I’ll make sure it stays that way.”

For these people, dysfunction is not some temporary, regrettable diversion from the goal of working together to solve problems. It is a long-term strategy, a tactic to discredit and then shrink government, with the ultimate goal of cutting taxes on behalf of their wealthy funders and deregulating the businesses that support them.

So, while I sympathize if your reaction is to just tune out yet another debt ceiling showdown, I implore you not to go there. It’s going to take outrage, not apathy, leading to action, not disengagement, if we’re ever to get out of this mess.