Monday, January 7, 2013

Debt Ceiling Dynamics

...chaos, painful chaos...
What would happen if Congress refuses to raise the debt ceiling? The answer is chaos, painful chaos that would have horrific short-term implications for not just the US but the global economy. Here's why.
Refusing to raise the debt ceiling of course could mean that the government is unable to send out social security checks in a timely manner, or otherwise pay its bills. Mind you, these are all programs duly legislated with expenditures authorized by Congress. So the proper way to do things is to change the law. If members of Congress don't think they can get re-elected if they do that, then ... but let me stick to the economics.
The real nightmare is the uncertainty this would throw into credit markets. The impact would be concentrated in short-term markets, because that's the debt that (by definition!) falls due. An awful lot of our economy is tied to those markets – money market funds, the prime rate that affects small business loans, car loans and credit card interest rates, and of course that also affects the holding cost of financial institutions with short-term funding needs. The Federal Reserve can work to keep the Federal Funds rate low, but that's an arm's length removed, and at best helps out banks. As we've seen, however, the straight banking portion of our financial system is a shadow of its former self, while the shadow banks have taken over.
Normally there's virtually no capital gains risk, upside or downside, in short-term markets – one reason that interest rates are typically much lower. But what if you have a Treaury maturing 5 days from now, and you're not sure it will be good. Now you will get your money, sooner rather than later, but the certainty is gone. Suddenly you're in a seller's market, and face a loss if you try to sell it -- but the possibility of no money on day 5 if you don't.
Now at today's interest rates – let's say 0.04% pa, the rate on a one-month bond at the end of December 2012 – well, a $1 million bond earns roughly $1 a day. But if you're a corporate treasurer that really needs the money to make payroll, you may well prefer to take a $100 loss on your $1 million – that is, get $999,900 today – than have a bunch of workers seeking to lynch you because their car payment check bounced. But that means a 4% interest rate – and if we look at what happened when Lehman failed, rates could go much higher.
That doesn't sound like much, but it would put money market mutual funds at risk, as many have committed to holding short-term Treasuries to minimize risk. Ditto foreign exchange trader from around the globe. With trillions of dollars traded every day, a jump in interest rates of that magnitude would throw a monkey wrench in the economy that would make the fiscal cliff look as flat as a bowling alley.

So I think that an administration pushed into a corner would in fact be willing to do almost anything, even delay social security payments, to avoid a bond default. But market managers won't want to place their careers at risk of politicians, most of whom are lawyers, failing to get their priorities straight. Unlike with the fiscal cliff, a last-minute compromise will thus still cause chaos.

I try to avoid hyperbole, but to me it would be treason – far more dangerous to the US than spilling top secrets – for Congress to use the debt ceiling as a political tool.

...mike smitka...


  1. Treason? Mike, that's a very harsh word.
    There's only one definition of treason in the Constitution. In the First Amendment, it's defined as raising arms against the government.

    Former Vice President Aaron Burr wasn't tried for treason when he worked with British agents and financiers to set up a new country in the Louisianna Purchase region, because the plans never came to the point of war. His plans were discovered and thwarted.

    In those days, the United States only had the constitutional definition in law.

    Attempts to define treason have led to some very questionable legislation like the Espionage and Sedition Acts. A lot of people thought they went too far.

    The Rosenbergs and Alger Hiss were convicted of treason even though the law technically required a state of war.

    Many people wanted to indict G W Bush for treason for getting the country into wars that cost over $4 trillion at a time when the country was alraady fragile economically. But Congress authorized the actions after the fact.

    No one investigated for treason when three buildings in the middle of NYCity did what no other building had ever done: fall straight down after being damaged on one side.
    One of the buildings fell seven hours later from a paper fire. It wasn't even hit by a plane.

    Afghanistan was an instant war. A shaky coalition, full of caveats and coercion, formed. The US and UK invaded. It's now the longest war in US history, and it's still not a declared war.

    The Pentagon and Bush administration controlled the press so effectively leading up to the Iraq war, most Americans never heard of the millions who gathered to protest against the invasion both in the US and around the world.
    Is that treason?

    Plans for both wars were drawn up from the earliest days of the Bush administration, forced onto the National Security Council by VP Dick Cheney.

    Both wars were planned as 'preemptive' in order to avoid the international defnition of aggressive war.

    Secty of Defense Rumsfeld announced the Iraq war would only cost "about $50 billion".

    The Bush 43 administration sent Secty of State Colin Powell to the UN with intentionally doctored and spurious evidence of WMDs.

    Cheney sought to define the vice presidency as being beyond the rule of law as neither a part of the legislative or executive branches. He acted under this unproven, potentially unconstitutional assertion to use private funds to set up an extra-constitutional government organization controlling all federal executive agencies.
    Is that treason? Whether it is or not, because the issue has never been resolved, the potential for any future vice president to do the same remains.

    In the beginning of the financial crisis, Geitner and Paulson wanted to give $600 billion, then $700 billion, to banks and other large insttutions with no strings attached. The country was already suffering from fiscal meltdown, with the loomimg debt from two wars unaccounted for in the budget.
    The amounts would have nearly doubled the raw money supply overnight, creating an immediate and apparently unavoidable risk of inflation.

    Only recently, gun control has split the nation. NRA-funded advocates accuse Pres Obama of treason for the 23 executive orders to tighten the enforcement of gun control legislation from the federal level.

    How many people think the Constitution enforces freedom to own firearms in order to overthrown a tyrranical or corrupt government?
    Is the misrepresentation of the Constitution by elected officials treason?

    Is the formation of un-regulated armed groups stating their intention is to take part in armed insurrection and overthrow the government treason?

    Are those militias any different from Muslim leaders who declare they want to remove the Constitution and replace it with Sha'ria law?

    Treason is a very hyperbolic term, and there may be many definitions that may never make it into law.

  2. I re-read the US Constitution the other day, prior to starting in on the Federalist Papers (which I've never read). I agree that under that definition merely fomenting economic meltdown would not qualify as treason. I wanted to pick a term that was hyperbolic, but "treason" is not the right one, at least from a constitutional or legal standpoint.