Even a Bad Debt Deal Beats the Alternative
As President Biden and Speaker McCarthy careen toward a budget deal that would clear the way for an increase on the debt ceiling and an avoidance of possible default (Roll Call), their respective intra-partisan rivals are already nervous. The Democratic left planted its flag with proposals for unilateral executive action (more on that later).
Some Democratic senators from the party’s left flank are looking for an end-run around any bipartisan deal that has tough pills for them to swallow.
A group of 11 senators, led by independent Sen. Bernie Sanders of Vermont, who caucuses with the Democrats, sent a letter Thursday to Biden urging him to raise the debt limit on his own by invoking the 14th Amendment to the Constitution, which says in part that the “validity” of the U.S. debt “shall not be questioned.”
Biden has said he is considering that untested option, but that it would face court challenges and would not solve the immediate problem because time is so short.
Meanwhile, the House “Freedom” Caucus is demanding McCarthy walk away from the table and … just fold his arms until the Senate and the president cave (WaPo). Both extremes seem ready, if not eager, to walk into the unknown – although the left’s version involves a potential legalistic way of avoiding default. They would tell you that makes all the difference in the world.
Bad Deal Beats Worse Reaction to No Deal
As a reminder, I was and am no fan of McCarthy’s debt-ceiling/budget reduction plan. It cuts defense spending, despite McCarthy’s attempts to hide it. It would cripple our efforts to support Ukraine. It would weaken us on the world stage. Whatever eventual deal is worked out may do less of these things, but it will still be a bad deal compared to what should have happened – a clean debt-ceiling increase and a serious discussion about the ways to limit actual government borrowing.
Unfortunately, the moment McCarthy scrounged up 217 votes for his ransom notice, what should have happened became all but impossible. There are some Democrats attempting to do it anyway via a discharge petition (Reuters), but the GOP majority is locked in on its economic kidnapping.
Again, from a legalistic perspective, anti-deal Democrats would appear to have the better argument by claiming Biden can cite Amendment XIV and declare the debt ceiling unconstitutional. However, there is no guarantee that would – or even should – survive a court challenge. More to the point, a different mathematical equation renders even the legality of it moot.
The Dark Side of Keynesianism (Forgive the Math)
Over the last decade and a half, Keynesian economics has made a dramatic comeback in political circles, thanks in large part to the demand-driven Great Recession. The problems Old Keynesianism had with the supply shocks of the 1970s have been largely forgotten in Washington. The problems with that are for another post. This one will show how even demand-driven economics forces one to accept a bad deal over no deal at all.
The standard Aggregate Demand equation remains as it has been for decades: GDP = Consumption (C) + Business Investment (I) + Government Spending (G) + Net Exports (NX). Note that Business Investment is not about stocks or bonds, but rather businesses spending on themselves (new equipment, plant expansion, increased inventory of goods, etc.). In “econ-speak” purchasing stocks or bonds is considered Saving (S).
This matters because at equilibrium, GDP as spending equals GDP as income. The latter equation goes like this: GDP = C + S + Taxes Paid (T). When the equations are combined, we get S + T = I + G + NX, or S + (T-G) = I + NX. In other words, the amount of business investment (and thus, capital formation) that occurs in Keynesian theory depends upon how much individuals save and how much government “saves” (in a budget surplus) or “borrows” (in a government deficit). Higher borrowing could pull funds away from Investment without greater private savings (including purchasing of government bonds) to make up for it.
This is even clear when one considers the rest of the world. By definition, Net Exports equals the difference in international savings (i.e., what we buy in foreign assets minus what foreigners buy in our assets). If we call the former Savings Abroad (SA) and the latter Foreign Savings (FS), we get NX = SA – FS. That can go into our combined equation, now S + (T-G) = I + (SA-FS). The final solution for business investment is thus I = S + (T-G) + (FS-SA).
In other words, for the long term economic growth that America needs, we either save more ourselves, reduce our savings in foreign assets, improve government finances, or increase foreign savings here.
It’s All About People
What we have to remember is this: all of those above actions are due to choices made by people. The more attractive American assets become, the more likely Americans and foreigners will buy them and the less likely Americans will “move their money abroad.” As for government finances, the last time America saw substantial government surpluses (1998-2001), we also saw a major increase in information technology investment and productivity – exactly what one would expect if government were borrowing less and the rest of the world (scared by the economic “Asian flu” of 1997) poured their savings into American assets.
Now imagine, on June 1, either America literally defaults or just her government is thrown into court by citing the 14th Amendment as a way out. Either scenario would cause mass economic uncertainty. All three variables driven by private action would go the wrong way. Domestic savings would plummet; Americans’ savings in foreign assets would soar; and foreigners’ savings in our assets would sink. All of these would cripple business investment and long term economic growth. It would matter exceedingly little even if the 14th Amendment scenario were actually viable (and while I’m not a lawyer, I have grave doubts). The years taken to resolve the matter would result in a body blow that would take decades from which to recover.
What the Deal May Look Like
As I write this, the deal is not yet done, but the contours are forming: a debt-ceiling made irrelevant until 2025, some form of increased work requirements for some anti-poverty programs, and some level of government spending reductions. One surprise: there may be tax increases (McCarthy’s ransom note did raise taxes on green energy). I’ve already described my concerns about the work requirements (a larger government workforce, more expensive IT programs, discouragement of entrepreneurship). The spending cuts, made in a rash of fearful negotiation, are more likely to be the unthinking “across the board” type cuts rather than the reform-driven savings we really need.
Again, though, that is compared to a clean debt-ceiling lift and a willingness to take the time to review government programs in detail. The House GOP took that off the table with their ransom note. As bad as Biden’s deal with McCarthy will be, I can’t see it being worse than the uncertainty caused by unilateral action on shaky legal grounds – to say nothing of an actual default.