The US debt ceiling debacle will begin all over again this Fall

Editor’s Note: 03 October 2013 – this post is outside the paywall now that a US government shutdown has occurred, with the Affordable Care Act as the nominal reason why the government has shut down. But given what is said below, it is clear that a showdown was coming and that any reason would have been manufactured to force this showdown on government spending and taxation.

Today’s commentary

Summary: Yet again, the U.S. debt ceiling is going to become a political football that could threaten the U.S. and global economy. While I don’t think the U.S. will default on its debt these recurring manufactured crises make the U.S. extremely vulnerable to policy error and could precipitate a global crisis.

Going back into the Credit Writedowns archives, I can see what the main issues were when the debt ceiling first became a political problem in the U.S.  I first mentioned the debt ceiling issue on 11 Apr 2011, writing that it was the inevitable outcome of increased polarization in the U.S. Read my piece from the next day anticipating the first debt ceiling showdown. The crux here is fourfold:

• A sovereign nation that issues debt in its own fiat currency like the United States cannot default involuntarily since it can always print money to meet obligations but it can default for political reasons.
• In the U.S., after a generation of redistricting seats in Congress to make them more ideologically cohesive, elected members of Congress are very polarized on a number of social and fiscal issues, particularly the deficit
• The Republican Party leadership does not want to force this issue but must do so because large parts of its base supports brinkmanship on the deficit issue as these parts of the base believe deficits are a threat to future U.S. solvency and prosperity.
• Therefore, until U.S. deficits are cut via decreased spending as opposed to higher taxes, there will continue to be recurrent manufactured political crises over the debt ceiling.

The debt limit was last increased in January. But the new ceiling will be reached by mid-October according to U.S. Treasury Secretary Lew and that would put the U.S. in a position where it would have to cut spending massively, default on its obligations or raise the debt ceiling. The sequester was an outgrowth of the January compromise that raised the debt ceiling last time. Initially, the sequester looked like something which could fully derail the U.S. economic recovery but it has not done so. Would a similar type of compromise this time derail the economy? It could. But the real fear has to be default or massive temporary spending cuts because those two outcomes would certainly lead to recession and market turmoil.

The emerging markets crisis resulting from the tapering of quantitative easing is certainly the greatest risk to the global economy right now. But as the debt ceiling showdown approaches, we need to keep this on the radar screen. The U.S. government will run out of money by November if a deal is not reached.

Update: Stan Collender noted the following in a post that came out after mine:

“There will be only 9 legislative days before fiscal 2014 starts on October 1. Approximately 15 calendar (but no more than 10 legislative) days later, the Treasury says the government will not have the cash it needs to pay all its bills. At that point either the federal debt ceiling will have to be raised so the government may borrow more or a technical or actual default will occur.”

This tells you that the debt ceiling issue doesn’t have a lot of time to get resolved. The potential for a policy error is large.