The year 2013 saw two debt-ceiling showdowns, both of which were scored as political wins for President Obama and the Democrats. Unfortunately, the way in which the Democrats won those battles all but guarantees that the war over the federal budget will continue, and that the cost of each successive battle will be needlessly high.
In 2014, as a direct result of the President’s ad hoc approach to dealing with Republicans’ hostage-taking in previous crises, we are guaranteed yet another nail-biting showdown over the debt ceiling, most likely in the middle or end of March. As I noted in my most recent Verdict column, Congressional Republicans have made it clear that they have every intention of replaying the insane scenario that they have embraced over the past three years, in which they insist that increasing the debt ceiling must be accompanied by policy changes of their choosing.
Will anything be different this time? So far, the Republicans have not announced the particulars of their demands, but their most extreme members have not hidden their disappointment (perhaps better described as outrage) with the December agreement that avoided government shutdowns for at least two years. This all but guarantees that there will be a bitter stare-down, accompanied by all of the damaging brinkmanship that has characterized recent budget crises.
All of that is, unfortunately, now old news. Even though we do not know what the Republicans will demand, we know that they will demand some kind of ransom, as the price of allowing the government to keep the promises that Congress itself has made.
What could be new in 2014, however, is that we could finally face a real catastrophe. If the Republicans decide not to blink this time, and the President holds firm, what happens next? Unfortunately, it appears that the President’s strategy all but requires action by the Federal Reserve, which would cause serious damage to the central bank’s crucial political independence.
Unless the President changes his approach, the Fed will be forced to spend enormous political capital defending the financial system. That damage could take decades to fix, if it could be fixed at all.
The President’s Simple, Dangerous Strategy
The White House has, by all appearances, decided that its 2013 strategy regarding the debt ceiling was a good one. Admittedly, they have some reason for feeling a bit of triumphalism about the year that just ended. In 2011, after all, they were completely blindsided by the Republicans’ first attempt to tie the debt ceiling to budget concessions, and the President—and, much more importantly, the country—has paid a steep price ever since.
Having failed so badly in 2011, by falling for the fantasy that the Republicans would negotiate in good faith on spending and taxes, the White House in late 2012 announced a simple strategy: There would be no negotiations over the debt ceiling. Adjusting the debt ceiling is a bipartisan responsibility, and the President would simply refuse to agree to anything but a “clean” increase in the debt ceiling, unencumbered by any other Republican policy demands.
To the White House’s credit, the debt ceiling truly is a law that should not be used in the way that Republicans have recently tried to use it. The debt ceiling is completely unnecessary, at best, because it should be adjusted to reflect whatever level of debt is required by lawmakers’ decisions about taxing and spending. Failing to increase the debt ceiling, therefore, would put the United States government in the position of possibly breaching its legally binding promises to people, businesses, and governments who rely on the full faith and credit of this country’s government. To refuse to increase the debt ceiling is to refuse to live up to our word. The consequences of that refusal would be devastating, both politically and economically.
Even though the President is absolutely correct in saying that the debt ceiling is not a legitimate negotiating tool, however, his simple strategy is anything but easy. And it is very dangerous. He must hold firm, hoping that the Republicans fold before it is too late. He must do so, moreover, under intense political pressure to capitulate and make a deal.
The President has thus far refused to follow the constitutionally required path, which is (as my Justia colleague Professor Michael Dorf and I have been arguing for quite some time now) to borrow the amount of money needed to meet the country’s legal obligations. Instead, the President has said that, if the Republicans were to refuse to increase the debt ceiling, he would feel compelled to begin defaulting on bills as they come due.
The political thinking by Democrats is obviously that the President will either win by getting the Republicans to back down again, or he will win the political blame game, by saying that the Republicans were the ones who forced the U.S. government to default for the first time in history.
Additionally, the Democrats have reason to hope that the financial interests who back the Republican Party would never actually allow the crazy Tea Partiers to carry through on their default threats.
The President’s simple strategy is thus dangerous on multiple levels. It guarantees at least a minimal amount of financial and economic disruption, while the stare-down continues and the clock ticks toward the moment when the government would no longer be able to pay its bills. While that is going on, decisions regarding private and public investment are delayed, and the economy’s growth is slowed or reversed.
The strategy also assumes that the Republicans believe that they would lose the blame game. More importantly, the President must be assuming that the financial wing of the Republican Party is ultimately in control of what House Republicans do, which further requires the assumption that the amount of damage done by the Tea Partiers over the last three years was annoying but acceptable to Wall Street, while a true debt-ceiling crisis would cause the Wall Street people finally to quell the rebellion by the riffraff.
Finally, and most worrisome of all, this strategy assumes that we can definitely pull back from the brink whenever Wall Street finally snaps it fingers. This, in turn, is based on the belief that crazy outcomes cannot happen, because non-crazy people can stop them from happening. Anyone who knows the basic history of World War I, however, knows that things can get out of control, even when “all the smart people” try to stop it from happening.
The President’s Implicit Reliance on the Fed
Perhaps, however, the President holds one last trump card. After all, a piece is missing from the White House’s announced no-negotiations strategy: What will the President do if the other side does not blink? As noted above, the President has said that he would then have no choice but to default. Of course, as a matter of gaming tactics, that is what he has to say, given his overall strategy. He cannot credibly say that the other side must blink, if he also admits that he would still have a choice that could avoid catastrophe.
But what would he really do? As the Buchanan-Dorf analysis shows, the President would have three choices: issuing debt, defaulting on legally binding payments, or increasing revenues. The President might think (incorrectly) that defaulting is the least damaging of the three, but he cannot deny that it would be his choice, if Republicans confront him with that “trilemma.”
During the most recent debt-ceiling crisis, which coincided with (and was overshadowed by) the government shutdown of October 2013, I described here on Verdict the role that the Fed would be all but forced to play, if the “drop-dead date” of the debt ceiling were to actually be reached.
Under that analysis, the Federal Reserve would play the role of savior. This would be accomplished by having the Treasury Department borrow money from the Federal Reserve (the latter being technically independent of the rest of the federal government). This, however, would simply mean that the debt ceiling had in fact been exceeded, but that the additional money was borrowed from the Fed, rather than from individuals, businesses, or domestic or foreign governments.
To be clear, under those dire circumstances, that is exactly what the Treasury and the Fed should do. But doing so would be illegal on the part of both entities. The Treasury would be exceeding the limit in the debt-ceiling law, and the Fed would be creating money for reasons that are not permitted under its enabling legislation. Even so, some invocation of emergency powers would surely be appropriate under the threat of global financial collapse, and the Fed could thus step in and prevent default.
To a certain extent, this story is a comforting one. It would seem, in fact, to be the ultimate fail-safe, making it unnecessary to rely on Wall Street to control the ultra-extremists in the Republican Party. There would be no reason to think that the Fed would fail when the moment of truth came, because the people running our central bank are clear-minded and competent, and they would not fall victim to the cascading circumstances that can lead inadvertently to catastrophe.
Again, however, the President cannot announce that, if worse comes to worst, he is counting on the Fed to back him up. He must still play out the drama, with all of the attendant uncertainty and economic damage, in order to try to force the Republicans to capitulate. Only when both sides had refused to blink would the Fed play the role of deus ex machina.
One could, in fact, view the tradeoffs that are involved as favoring the White House’s preferred strategy. One could argue (although I would strongly disagree) that it would be too easy for Republicans to demagogue the Buchanan-Dorf strategy, saying that the President has engaged in a power grab. (As I have argued before, they could even impeach him—although they could also impeach him for presiding over the very default that they are now saying would be required.)
Under that view, the political and economic harm of periodic debt-ceiling crises are an unfortunate cost necessitated by Republicans’ hostage-taking. While regrettable, the hope would be that the Republicans would step back from the brink each time, ultimately concluding that it was not worth it. And if Armageddon ever actually loomed, the Fed would do what it must.
The Fed Should Not Be Forced to Compromise Its Independence
What this story leaves out, however, is the cost that would be borne by the country if the Fed were seen to be saving the President in the midst of a bitter political dispute with Republicans.
The Tea Party wing of the Republican Party includes large numbers of people who already view the Federal Reserve with suspicion and loathing. Senator Rand Paul leads the charge for the heirs of the people who thought that fluoridation of the water was a Communist plot, repeatedly accusing the Fed of debasing the currency and causing (rather than mitigating) economic disasters.
Even people who are not susceptible to conspiracy theories are generally unclear on how the Fed works, or for that matter, what a central bank is. Indeed, even financial writers sometimes embarrass themselves by complaining about money being created “out of thin air,” and similar nonsense.
The Fed’s legal independence is a prerequisite for its political insulation. Although the Fed has been criticized from both the left and the right as being too removed from the people (and being a tool of the moneyed interests), the only reasonable debate is over the degree of the Fed’s independence, not over that independence itself.
As the last five years have demonstrated, the Fed’s political insulation was essential in allowing it to try to fight the ongoing damage from the Great Recession, even as fiscal policy was hijacked by a combination of anti-government extremism and the false centrism of “deficit scolds.” The U.S. has experienced a weak recovery, but it would have been much worse if the same political dysfunction that destroyed rational budgeting had infected monetary policy as well.
In short, the President’s strategy regarding the debt ceiling puts the Federal Reserve potentially “in play,” in a way that could do lasting damage to our country’s economic decision-making. If faced with the threat of default, due to Republican intransigence regarding the debt ceiling, the Fed will surely fall on the hand grenade. The damage to the Fed (and thus to the rest of us) from doing so, however, would be truly fearsome.
There is already tinfoil-hat support for abolishing the Fed. The President should take into account just how much worse matters could become if he indirectly forces the Fed to appear to engage in a partisan political tactic, in order to save the President from a failed stare-down strategy. There are no good choices facing the President, but hanging the Fed out to dry would be among the most dangerous choices of all.