Here Comes the Debt Ceiling

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The fiscal cliff was always going to end with a whimper because that was the obvious path of least resistance. In the end, simply avoiding big tax increases and spending cuts while adding a few more trillion to the coming decade’s deficit was rewarded by the markets with a huge rally. Everybody went home happy, or at least still in possession of their political office.

Now we move on to the debt ceiling, which on the surface looks just like the fiscal cliff: A self-imposed set of penalties that can be finessed with the stroke of a pen. But it’s likely to be far messier, for a couple of reasons. First, the republicans got rolled in the fiscal cliff deal because they couldn’t stomach middle class tax increases and defense cuts. They were forced to raise taxes on their main contributors without cutting spending on the democrat base. This was a massive defeat for the supposed party of small government that cannot be repeated short of intra-party civil war.

The other reason is that simply raising the debt limit (for the umpteenth time) might actually have some political downside this time around because it requires admitting that Washington’s debt will rise by another $2 trillion in the next year or two, to around $18 trillion. The human mind doesn’t grasp “trillion” very easily, but it does get round numbers like 20, which is now rapidly approaching. Put that new handle in front of something incomprehensible but ominous like trillion – and then note that a decade ago it was below 10 — and you have, as they say within the Beltway, an optics problem.

The republicans can exploit this to demand spending cuts. The democrats will refuse on principal and counter with tax increases, and both sides will see a reasonable chance of blaming the other if the thing goes sour. So nothing will get done until checks actually stop being sent out. Here is the Wall Street Journal’s Kimberley Strassel on the republicans’ situation:

Strassel: The Debt-Ceiling Fight Will Be Dirty

The GOP thinks it will win, but the party’s strategy is far from clear.

In the classic movie “The Untouchables,” the street-smart cop Jim Malone explains to his golden-boy partner Eliot Ness that things will have to get dirty if they intend to bring down Al Capone: “You see what I’m saying is, what are you prepared to do?” That’s the question for the GOP as it sifts through the ashes of this week’s cliff deal.

The tax-hike extravaganza that President Obama signed on Wednesday was Round One of a bigger deficit fight, and the GOP was battered badly. Poor messaging, an internal tax feud, and a miscalculation of the president’s tactics—all combined to land the private economy with a monstrous tax bill, and the Republican Party with a black eye.

On to Round Two, which will center on the debt ceiling due to hit in February. Republicans are convinced they can win this one. Their thinking? The president can’t use the threat of higher middle-class taxes to force the GOP to yield. Without the middle class as a hostage in the negotiations, they believe, the debt-ceiling debate will be entirely on spending and Mr. Obama’s failure to confront the nation’s $16 trillion debt.

The White House feels this keenly, as exhibited by the ferocious threats the president leveled in the aftermath of his tax-increase victory. “If the Republicans think that I will finish the job of deficit reduction through spending cuts alone, that’s not how it’s going to work,” he said in a Monday press conference. Translation: He will demand more taxes.

The president is steeling himself for Round Two. Are Republicans? For all the happy talk about their leverage in the debt-ceiling fight, this is going to be dirty. What are they prepared to do? They face three big questions.

Question one: Do they mean it? In the abstract, the debt ceiling is a powerful tool for forcing the president to give in to spending cuts. The Obama Treasury can’t pay the bills without say-so from the Republican House, so the House holds all the cards.

In the non-abstract, failure to raise government borrowing limits means U.S. default—and with it potential credit downgrades, market panic and resulting economic distress. Is the GOP willing to inflict that on the economy? If Republican members instead run for cover, as they did with the cliff, the GOP will have been exposed as bluffers, and the administration will never again have to fear the debt ceiling. Republicans have to consider if they are willing to take that risk.

Question two: What do they want? Throughout the fiscal-cliff negotiations, the Republicans kept thinking Mr. Obama would sign on to entitlement reform, giving both parties political cover. In this vain hope, the GOP shrunk from laying out its specific demands on Medicare, Social Security and Medicaid.

President Obama didn’t bite, and he won’t in the future. The GOP must know by now that the president’s only goal is to water down any reform proposals. So their only chance of making a dent in the debt is to begin bold.

Do House Republicans have the courage to lay out big demands (say, premium support for Medicare or block grants for Medicaid), send a bill to the Senate, and sell entitlement reform to the public? If they can’t face the demagoguery that Democrats will use against them for making substantive proposals on entitlements, then they have already resigned themselves to piddling spending cuts that only nibble around the entitlement edges. Is that worth an epic showdown?

Question three: What other hostages are Republicans willing to see shot? Knowing he has lost his tax trump card, Mr. Obama seamlessly moved on this week to the defense budget. The cliff deal turns off the automatic sequester cuts to the military for only two months, and Mr. Obama intends to make further tax hikes the price for anything longer.

Are the GOP’s defense hawks willing to stomach those cuts as a price for entitlement reform? Having publicly campaigned against this slashing of the military, can the party stare down the president with a unified position? Mr. Obama is betting they can’t, which is precisely why he ensured in the cliff deal that the sequester kicks in at the very time of the debt-ceiling fight.

Only the GOP can answer these questions, but the point here is that Republicans had better have answered them—and clearly—before they step into the ring. The president has every intention of playing them exactly as he did in the cliff, and in 2011.

Mr. Obama will lay out tax-hike demands, give no quarter on spending, not waver and, as the deadline approaches, use his bully pulpit and the media to cow the GOP into the sort of wrangling that led to this week’s defeat.

If the Republican strategy isn’t crystal clear, if the party is again fractured, then Round Two is already Mr. Obama’s. So once again: What, exactly, is the GOP prepared to do?

Some thoughts

Now for the big picture question: why is all this happening? How did we morph from a somewhat functional country to one where debt rises in multi-trillion dollar chunks while the politicians who do the borrowing get reelected? The answer, as with so many other things, is the printing press. We’ve been able to simply borrow money and create new currency out of thin air for so many decades that as a society we’ve lost the impulse to prioritize. Instead, we simultaneously build a global military empire and a cradle to grave welfare state, and charge the excess cost to our grandkids. At the same time we develop an aristocracy of bankers and politicians who, because they get first crack at those newly-created dollars, have become all-powerful.

As a result both sides, left and right, see the other as having won. The left sees rapacious banks and corporations (the 1%) devastating broad sections of society while vacuuming up an ever-larger share of national wealth. The right sees ever-expanding entitlements and public sector unions crowding out wealth creators and turning the US into a socialist dictatorship (read France). Thanks to the magic of the printing press, they’re both right.

So here we are. Each side is so disgusted with the other that bipartisan compromise – which requires a degree of respect – is impossible. And even if it suddenly became possible, the imbalances are so huge that actually fixing the system by gutting both the military empire and the welfare state could never be sold to voters.

Fiscal policy, in short, is on auto pilot and the “off” button is disabled. Defense spending growth can be slowed a bit, but only a bit since the right still views the US as the world’s hyperpower and is willing to borrow whatever it takes to maintain this illusion. Entitlement spending can’t even be slowed, given the fact that baby boomers are retiring and have the political clout to guarantee free health care and nice monthly social security payments for the next three decades. No one, left or right, is brave enough to explain to my generation that its demands will bankrupt their grandkids. Add it all up, and US federal spending will rise by 8% a year until the market, not the voters, decides otherwise.

This puts all the pressure on monetary policy, the last relatively-pain free disaster-management tool. So here’s a prediction for the near future: After a few weeks of entertaining political theater, the debt ceiling will rise enough to get through the next congressional election. The Fed will continue to buy up most newly-issued Treasury paper but at some point will  begin making noises about ending QE. The markets will recoil (stocks will fall, revealing the massive underfunding of state and local pensions, among other things), and politicians will threaten the Fed’s independence. Ben Bernanke or his successor will see no choice but to oblige with more QE. See Japan in late 2012 for a template.

Source: Dollar Collapse

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