Barron's Streetwise - The Debt Ceiling Is Riskier Than It Looks

Episode Date: September 17, 2021

Default is unlikely this year, but "stupid things seem a lot more possible," says one budget expert. Learn more about your ad choices. Visit megaphone.fm/adchoices

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And those terms are holding it hostage and game of chicken. Welcome to the Barron Streetwise podcast. I'm Jack Howe. The voice you just heard, that's Maya McGinnis. She's the president of a government spending watchdog group called the Bipartisan Committee for a Responsible Federal Budget. And part of what she does is explain the nation's complex and at times confounding financial plumbing to the rest of us. You've no doubt heard of a fiscal showdown that Congress has from time to time over something called the debt ceiling. That's back on Wall Street's worry list. And in a moment, Maya will explain how the debt ceiling debate is likely to play out in the weeks ahead and how it

could inflict real economic damage in the years ahead, and how it could inflict real economic damage in the years ahead, and what should be done to keep that from happening. This episode is not a budget scolding. Not chiefly, at least. This episode is not a budget scolding, not chiefly at least. This is specifically about fighting over the debt ceiling, which, as I'll explain, has nothing to do with being responsible on spending and makes as much intellectual sense as a self-administered wedgie. We'll come to that.

Let me start with a brief update on where America's balance sheet stands now. update on where America's balance sheet stands now. Back in 2007, the year the first iPhone came out, the federal debt was 35% of gross domestic product, or GDP. In other words, we owed about one-third of a year's worth of economic output. This year, the debt is expected to hit 101% of GDP, so we now owe more than our yearly economic output. So what happened? Well, three main things. Two of them were dire recessions. The first was brought on more than a decade ago by the collapse of a housing bubble, and the second by the pandemic shutdown. Policymakers responded to both of these with vast spending on assistance for businesses and individuals. The third thing is a round of sweeping 2017 tax cuts that weren't offset by spending cuts. When Congress takes in

less in taxes than it spends, the result is called a deficit. Sometimes I hear people using the terms debt and deficit interchangeably, but technically the debt is the amount we owe and the deficit. That's the amount by which we go further into the hole each year. The Congressional Budget Office, which is made up of statisticians and not politicians, expects borrowing to grow significantly faster than economic output in the years ahead. than economic output in the years ahead. The record for U.S. debt as a percentage of GDP is 106 percent reached right at the end of World War II, when two out of five workers were either in the military or making munitions, and when the top tax rate for high earners had reached 90 percent. As things stand now, we could once again hit 106% of GDP over the next decade and shatter the record by 2050 when debt hits 195% of GDP. Needless to say, this has deficit hawks concerned.

I spoke recently with Lawrence Kotlikoff, who's an economist and professor at Boston University and who writes books about budgeting and sometimes runs for president, and who has a new personal finance book coming soon called Money Magic, an economist's secret to more money, less risk, and a better life. In Larry's view, America's fiscal condition is much worse than I've just described because there are large future funding obligations for things like Social Security shortfalls, which aren't counted as debt, but should be. The Social Security Administration last week in a trustee's report telling us that they're running a $60 trillion unfunded liability. So the off-the-book deficits are much bigger than the on-the-book deficits. In Larry's view, the country is in debt not just by one year's worth of GDP, but

eight to 10 years worth, depending how you do the math. We are in worse fiscal shape than any advanced country. And this is the result of running seven decades of a Ponzi scheme. Okay, that sounds troubling. But there's another point of view here that holds that these numbers aren't as dangerous as they seem. Back in July of 2020, we had economist Stephanie Kelton on this podcast to explain modern monetary theory. In the simplest terms, she says that for countries that issue their own currency, like the U.S., deficits and debts are merely a self-imposed restriction because America could simply create more money to pay what it owes.

So the only real restriction on the ability to spend is the availability of resources and a desire to keep the rate of inflation reasonable. Here's Stephanie at a recent TED Talk. And by the way, if you keep hearing the phrase TED Talk and you've been wondering who this TED is, there's no TED. It's an acronym for Technology Entertainment Design. And there's a media group called TED Conferences, which has been holding meetings for more than 30 years. Today, the topics include politics and social issues, and there are videos archived online,

some of which have millions of views. The two things to know about TED Talks are that speakers are limited to 18 minutes, which forces even long-winded ones to stick to their best stuff. And if you're at a party and someone who's been talking for a couple of minutes says, anyhow, thanks for listening to my TED Talk, That's a punchline that roughly translates to, I'm self-aware enough to realize it's time to move on. And with that little TED Talk out of the way, here's Stephanie from her recent actual TED Talk titled,

The Big Myth of Government Deficits. Can we build affordable housing and fix crumbling infrastructure? Can we expand Medicare to include dental, vision and hearing? Can we tackle our climate crisis? As Congress debates these questions, everyone is back to asking, how will you pay for it? It's the wrong question.

In fact, the right questions don't involve money at all. Instead of worrying about where the financing will come from, we should be asking, are these things worth doing? And do we have the real resources, the people, the equipment, the raw materials, and the technology to do them? Now, I'm not an MMT convert because I was raised in a penny-pinching family, and it's hard for me to get my head around deficits not mattering. And because I worry that although we've had big deficits and limited inflation for many years, on average, that when inflation returns in earnest, it might not be so easy to contain. But I also like hearing a diversity of

views, which is why I like talking with Stephanie. I've written about MMT that deficits have grown so large and persistent that the debate over whether MMT makes sense is almost moot at this point, that we should at least focus on whether we're spending on the right stuff. Now then, the debt ceiling. The first thing to know about the debt ceiling is that despite the name, it hasn't done anything to keep the debt from rising. The ceiling was created by something called the Second Liberty Bond Act back in 1917, when Al Jolson and Charlie Chaplin were out pitching bonds as a patriotic way to pay for World War I. The Second Liberty Bond Act empowered the Treasury to raise the debt without specific permission from Congress. To keep things from getting out of control,

there were limits or ceilings placed on various types of debt. Decades later, the Public Debts Act of 1939 consolidated these ceilings to a single ceiling for just about all types of debt. And that ceiling held for two years until World War II. And then it was raised, and it was raised again the following year, and the one after that, and the one after that, and the one after that. But then the ceiling held, for almost a decade, until it was raised to pay for the Korean War. And there have been a lot of debt ceiling increases since then, spread across many presidents from both political parties. In all, the ceiling is just over 100 years old, and it's been raised around 100 times. Maybe ceiling isn't the best term for something that moves so much.

I mean, maybe we should call it the debt hat. Crises over the debt ceiling are a fairly newer creation. There was a 1995 budget showdown between then-President Bill Clinton and a Republican Congress, including House Speaker Newt Gingrich. Now, if the president wants to veto the debt ceiling, then whatever happens in the markets Monday is because of his decision. It resulted in two government shutdowns, and the debt ceiling at the time could have interrupted Social Security checks going out, except that Congress gave the Treasury special permission to borrow funds for

that purpose that didn't count toward the debt ceiling. Ultimately, a deal was reached and the ceiling was raised. Remember the Tea Party movement? Back in 2009, after the housing bubble had popped, the Obama administration introduced a plan to limit foreclosures through refinancings, and a CNBC host named Rick Santelli had a spirited reaction on the floor of the Chicago Mercantile Exchange. They're like putty in your hands. Did you hear? No, they're not, Joe. They're not like putty in our hands. This is America. How many of you people want to pay for your neighbor's mortgage that has an extra bathroom and can't pay their bills? Raise their hand. How about we all? President Obama, are you listening? How about we all stop paying our mortgages?

Those comments became a viral video, and the idea of a modern-day Tea Party to restore fiscal order began to take hold. And Republicans took back control of the House of Representatives the following year. And the year after that, in 2011, they used the debt ceiling as leverage to demand big spending cuts. In 2011, they used the debt ceiling as leverage to demand big spending cuts. The end result was a complicated agreement that raised the debt ceiling and and a rise in interest rates, which government accountants later estimated had cost billions of dollars in increased borrowing expenses. So when another debt ceiling crisis presented itself in 2013, Congress suspended the debt ceiling, which is apparently a thing it can do whenever it wants. It was a short suspension,

but there have been a total of seven of them, which has made it a long suspension, and the last one expired at the end of this past July. That has left the federal government reaching under its couch cushions for money to pay its bills. But the consensus is that without a debt ceiling increase by mid-November, it will default. by mid-November, it will default. To learn more about whether this make-believe emergency could create real problems, I reached out to Maya McGinnis at the Committee for a Responsible Federal Budget. She says the matter will be resolved this year because it has to be. I asked how it'll happen. So there's two major paths of what could happen. If the Republicans hold to the position that they are not going to help with this debt ceiling increase, which is a position I think is quite wrong, then Democrats will have to include it in reconciliation and they will go forward with a Democratic supported only

debt ceiling increase. The other path is that Republicans decide that they will go along and increase the debt ceiling. And let me say why they should. The debt ceiling is accommodating a lot of borrowing that has already been passed. This is not merely saying, oh, President Biden and Democrats, you want to borrow all this money for this new reconciliation bill and all of this investment. It's actually accommodating borrowing already on the books. This gets to the heart of why the debt ceiling standoff has nothing to do with fiscal responsibility. The money has already been spent, and that spending won't be covered by tax receipts,

and that means the deficit will be added to what the government already owes, whether we call it debt or not. A debt ceiling standoff will do nothing to change whether the money is owed. It'll only determine whether America makes good on its debt. And whether America makes good on its debt will determine, among other things, the interest rates it's able to pay on future borrowing and debt refinancing. Right now, bond yields are exceptionally low, which means that markets don't consider the debt ceiling a serious threat.

And that's a good thing, but the complacency gives policymakers a chance to ramp up the bluster without fear of blowback. That's a dangerous thing. I don't do party politics, and I'm not nearly smart enough to explain congressional lawmaking gimmickry, but here's as much as I can tell you. The reason Maya can be confident that the debt ceiling crisis will be resolved is that Democrats control 50 votes in the Senate. Republicans could block a budget bill with the filibuster, but there's a loophole process for spending and revenue bills called reconciliation that requires only a simple majority. So Democrats can do this on their own. The reason they want Republican votes is so Republicans don't then later campaign

for re-election saying, hey, we tried to stop those Democrats from borrowing more, but they went ahead and did it without us. And the average voter, God love them, has no idea that the debt ceiling is just performance art, not an actual tool for containing the debt. Here's Maya. We're going to be borrowing one, one and a half trillion dollars a year for the coming years Here's Maya. if you're going to break things out into parties, which I don't love to do because we're one country and I wish that's how we acted. But everybody owns some of this debt. So the Republicans should be willing to vote for this debt ceiling increase. I asked Maya, can you think of a future scenario where the escape hatch wouldn't work, where something goes wrong and the debt ceiling doesn't get raised or suspended in time? I mean, the answer is absolutely. Certainly, if you had divided government, it becomes much more difficult.

Because in the end, we know that there's a failsafe that Democrats could pass this on their own. Now, there's still problems that could happen this year. Somebody could die. Somebody could be incapacitated. Somebody could not be able to cast a vote that they need. I mean, there are different scenarios, I assume, which could suddenly muck this all up. And my hope is that leaders are still behind the scenes working like adults and know what their plan B is for any of these scenarios. Maya says one thing that could go wrong is that there could be a debt ceiling standoff at a moment

when Congress doesn't have the reconciliation option. She says it's very late in the year to be able to use it. She explained why, but if I'm being honest, not all of it took. I was trying to picture how it relates to the old I'm just a bill cartoon they used to play on Saturday mornings when I was a kid. Well, I wonder who that sad little scrap of paper is. I'm just a bill. Yes, I'm only a bill. But it sounds like we're way beyond that now. Here's Maya. Quick tutorial on how it works. The president offers his or her budget proposal early in the year. Then the Congress takes up either that or starts fresh and passes budget resolutions first out of their budget committees, then out of the full bodies, then they reconcile the differences, then you have a budget in place and you do the appropriations process. Everything

is wrapped up by the end of September. That doesn't happen anymore. What is one of the more egregious things going on in this moment is that both budget committees, the chairman never even bothered to develop real budgets this year. They haven't even come out with the blueprint for how we're spending money. And so what they did do instead was kind of did an end run around the process and just said, we're going to use this reconciliation tool. This is going to allow us to borrow a lot of money. I hope and pray that they will. But today I am still just a bill. Sorry, back to Maya. We're going to be able to pass the Biden agenda on investment without the threat of the filibuster. So with only a simple majority in the Senate and at the last minute, that is available for the debt ceiling as well.

But normally, if the budget process were moving forward, we would already have moved all of these things throughout Congress, and we'd have this wrapped up for the year, and there wouldn't be a last-minute reconciliation tool hanging out there, which you could dump things in at the last minute. Okay, so if I understand correctly, our nonsensical lawmaking procedures offer a last-minute way out of our also nonsensical debt ceiling crisis. But Maya says there's something else that could go wrong in future years, and it's much simpler. If the two parties decide to play a game of chicken and enough members say, actually, we're not worried about defaulting or we think it's worth it, a position that is highly, highly reckless, this could happen. I think the lesson is we've gotten to the point where the debt ceiling in its current form has

outlived its usefulness. Because even though it's only a tiny risk that we could default, it's enough of one that we shouldn't be letting a risk that is purely a stupid act sit on the table threatening us. And in a moment where we're so polarized and dysfunctional, stupid things seem a lot more possible than they did in years past. I wish I could tell you that sounds ridiculous, but I've seen acts of partisan anger and idiocy over the past year that I never thought I would see. The debt ceiling seems like something with no potential upside and plenty of potential downside. Almost no other developed country has a debt ceiling. Denmark has one, but it was last raised in 2010, and it's so far above Denmark's debt that no one talks about it. Germany, Canada,

the UK, the Netherlands, none of these have debt ceilings. Back in 1987, the late actor and comedian Buddy Hackett delivered an astute analysis of game theory, the field of economics that deals with competitive situations. Only he disguised it as a joke about a duck, told the Johnny Carson on The Tonight Show. A hunter shoots a duck, which falls on a farmer's barn. And when he goes to retrieve it, the farmer says the duck is rightfully his because it's his property. The two men argue for some time until the farmer proposes a peculiar way to settle the matter. He says, we'll take turns kicking each other in the groin until one gives up and the other one gets the duck.

And the hunter doesn't want to back down, so he agrees. The farmer delivers a spectacular kick and the hunter falls to the ground and rolls around in pain for 30 minutes. Then he stands up and says, I guess it's my turn. And the farmer says, you can have the duck. My turn. And the farmer says, you can have the duck. I could swear Buddy was trying to warn us about the debt ceiling.

He was saying, if you're going to fight over something, make sure the prize is worth the potential for harm. The prize for the debt ceiling standoff is a handful of politicians getting to say bad things about a different handful of politicians. But the potential for harm is triggering a financial disaster that could do untold damage to ordinary savers. And just because we've avoided that during past standoffs doesn't mean we will during future ones. There's a simple fix, abolishing the debt ceiling. But Congress won't do that because politicians have spent so long trying to convince voters that the ceiling is part of a noble stand. And many voters believe that because the details are complicated and most people are too busy and distracted living their lives to follow closely. But Maya has a different idea. She says the

problem with the debt ceiling is it comes after the fact, after Congress has passed legislation on spending that will lead to more debt. She says the two things should be combined. So if in 2017, when there was a Republican-only tax cut that was passed that added trillions to the national debt, they should have been required to simultaneously vote that they were willing to increase the debt ceiling to accommodate that, or they should have had to go back and make a tax that didn't increase the debt as much. The same would hold true for different policies that are going on now in reconciliation or not. This big three and a half trillion dollar bill that the

Democrats are looking at, they should also have to vote to increase the debt ceiling to accommodate for that level of debt or bring that borrowing down. That would mean the accountability for the borrowing comes at the same time that authorizing that borrowing does. Right now, separating the two means you have a lot of people who are able to say, oh yeah, I want to borrow this money. And then a few months later say, I'm not going to prove paying for this money

that we've borrowed. Unlike Stephanie Kelton, Maya is not a fan of modern monetary theory at all. But whether you're more of a Stephanie or a Maya, or whether you're just a bill sitting there on Capitol Hill, surely reforming the debt ceiling makes sense. If there's a sliver of agreement between Maya and Stephanie, it's that Stephanie says the right question to ask is, what are our priorities? And Maya says that one of the things we miss out on by not going through a normal budget process is that we don't get a chance as a nation to think in an organized way about our priorities. But that's about it for fiscal overlap. Maya says if we borrow until we get hit with inflation,

it could end painfully. There's no tooth fairy. There's no Santa Claus. Hope no kids are listening to your podcast. And MMT could lead to a whole world of hurt when we push it to the limit. If there's no tooth fairy, why did my wife make me slip 10 bucks under my son's pillow the other day? I said, 10 bucks. I got 25 cents. I had the same thing. There were some other parents at the school who put a 20 under a pillow. I was like, I think a quarter is still what it should be. I got to talk to the Bureau of Labor Statistics and let them know what's going on. I bet we could make a really good point if they realized they weren't calculating

the tooth fairy inflation that is surely going on. realize they weren't calculating the tooth fairy inflation that is surely going on. Thank you for listening. If you have a question you'd like to hear answered on the podcast, just speak it or sing it into the voice memo app on your phone and send it to jack.how, that's H-O-U-G-H, at barons.com. Jackson Cantrell is our producer. Subscribe to the podcast wherever you listen. If you like the podcast, write us a review on Apple. And if you hate it, email Jackson. And for goodness sake, follow me on Twitter. That's at Jack Howe, H-O-U-G-H. See you next week.