Debt Ceiling: Once more unto the breach

Politics in the United States is starting to cause more problems than it solves as compromise still seems far off.

Politicians are not usually seen in the best light.  Even in that context, the partial shutdown of the federal government in the United States is exasperating, so much so that Your Neighbourhood Economist was not even going to bother to comment.  The situation leading to the shutdown brings to mind kids in a playground fighting over a toy with everyone losing out after all of the toys are put away.  However, behind all the antics and posturing, there are bigger themes at play which is even more depressing.

October is marked with a number of dates which gradually ramp up the economic stakes.  The month began with the US government having failed to pass legislation for its spending budget for the 2014 fiscal year which starts on 1^st October.  While the bulk of spending by the government, such as benefits for the elderly or unemployed, is not affected, a significant portion of money doled out by the government must first be ratified by Congress before being spent.  As a result, not passing the budget resulted in a partial shutdown of the federal government with around 800,000 out of 2.8 million public employees being sent home without pay.  The parts of government affected include bodies such as the Environmental Protection Agency and the Food and Drug Administration, meaning that many procedures such as permits for certain business activities will not be processed.  NASA will also mostly shutdown as will many of the tourist sites overseen by Federal government employees.

But the partial government shutdown is just a precursor to something more threatening – the government running out of money to pay its bills.  While such an outcome may sound preposterous, it stems from the current budget deficit (with the government spending more than it receives) and the need to borrow to make up the shortfall.  The total amount of debt that the US government can take on is also something that requires approval from Congress.  With the government having racked up a string of budget deficits in the aftermath of the global financial crisis, the amount of borrowing has been steadily rising.  More debt is needed but the government has reached the debt ceiling which was raised in 2011 and is expected to run out of money by around 17^th October.

The stakes are higher if no deal can be done with regard to the debt ceiling.  While the partial shutdown of government can be seen as a bit of a nuisance, a government cash shortage could have global ramifications if it means that the government misses an interest payment on its bonds and thereby triggers a default.  Given that US government bonds are akin to another form of currency in the financial system, a default has the potential to bring the global financial system to its knees. 

In spite of this, the financial markets, while on edge, have not panicked - negotiations regarding the raising of the debt ceiling are still on-going, and even if a deal cannot be brokered, the effects are still unclear.  There are other sources of income such as money from taxes so the government will be able to keep up with some outgoing payments.  But that in itself creates another dilemma – which, if any, payments to forgo.  Investors would hope that debt payment would take priority over, for example, the payment of pensions.  Despite the potential consequences to the international financial system, it would take a brave politician to cut off pensions for old people.

Considering what is at stake, the consensus view is that the politicians will sort themselves out before the government is forced into making such choices.  Your Neighbourhood Economist would like to assume that this will be the case.  But the two main political parties have been squabbling for number of years with the situation getting worse rather than showing any signs of improvement.  Over the past few years, there have been skirmishes over a previous increase of the debt ceiling in 2011 as well as the negotiations regarding the fiscal cliff less than 12 months ago (for more on this, see Winning the election was the easy part) and one of the key obstacles to compromise is growing in strength – that being the so-called Tea Party portion of the Republican Party.

The Tea Party is the radical anti-government element of the Republican Party which is not afraid to be aggressive in pushing for a reduction in the size of government among other policies.  Its members in Congress are targeting large concessions from Obama to raise the debt ceiling – a position which is further fortified by Obama having conceded little in previous showdowns.  Perhaps the biggest concern is that the anti-government fervour of the Tea Party will translate into a view that the debt ceiling is an effective way of slashing government spending irrespective of the costs involved.

The Tea Party has found growing support among Americans disillusioned with the role of the government.  It is part of the rise of populist movements that can also be seen in Europe which rail against mainstream policies, such as an opposition to immigration.  The multi-party political systems in Europe can include such movements as separate parties which often struggle to get the necessary level of support to make it into government.  The political system in the United States only has two political parties and the Tea Party essentially controls a large portion of the Republican Party.  With voting districts in the United States having been shaped over the years to produce safe seats for either the Republicans or the Democrats, Tea Party candidates in Republican seats are typically better at whipping up support enabling them to win out over more moderate candidates. 

The Republican Party as a whole has increasingly felt the need to pander to this radical fringe which has brought a heightened level of conflict to US politics, within the Republican Party itself as well as between the two major parties.  Its unique system of democracy has been a key element behind the successful rise of the United States to global dominance.  But with the country’s place at the top of the global pecking order no longer assured (as described in A New Inconvenient Truth), it would be ironic if its political system was central to its downfall.