The Do-Nothing Scenario, Or: What a Debt Crisis Looks Like


The Republican budget plan put forth by Rep. Paul Ryan is far from perfect. But it offers a vision of a more limited federal government—and an alternative to the nation's "daunting," "unsustainable" fiscal course. It's a serious attempt, in other words, to stave off debt-driven disaster. Naturally, Democrats have made it clear that they don't like Ryan's proposal. What they haven't made clear, however, is what they would do to address the debt problem. That may prove politically savvy in the short term. But regardless of how public opinion about Ryan's proposal shakes out now, I'm fairly confident in saying that most people—perhaps even most of Ryan's Democratic opponents!—would prefer it to the budgepocalyptic, do-nothing alternative: actively flirting with a debt crisis.

The debt ASPLODE!

As a refresher, here's the sort of thing the boring, cautious budget-minders at the Congressional Budget Office are saying about federal debt levels: "Over the past few years, U.S. government debt held by the public has grown rapidly—to the point that, compared with the total output of the economy, it is now higher than it has ever been except during the period around World War II." So it's not just high, it's unusually high. What does that mean? Do nothing, and, the whole system makes like one of those freaky heads from Scanners and explodes: In the absence of significant reforms, CBO says, "growing budget deficits will cause debt to rise to unsupportable levels." Emphasis on the word "unsupportable." That means we can't do it any longer.

Running historic debt levels also mucks up our national credit score, which pulls us closer to a debt crisis. Here are those buzzkill budget wonks at the CBO again: "A growing level of federal debt would also increase the probability of a sudden fiscal crisis." Bad news, right?

But how bad? What does an all-of-a-sudden debt crisis really look like? Economist Arnold Kling, a member of the Mercatus Center's Financial Markets Working Group, tells me that "what it probably looks like is a relatively sudden, sharp jump in yields on U.S. government debt. This probably would start at the long end (10-year Treasuries) and work its way back to the short end, so that even 3-month Treasury bills would see yields rise."

The run-up in interest rates would be fast—Kling guesses it would be just "a matter of weeks"—meaning there would be essentially no time to prepare. Watching interest rates won't serve as a warning system. When the crisis came, the only possible response would be massive, immediate cuts or similarly drastic tax hikes. According to Kling, "the government would have to quickly find a way to raise tax revenues or cut spending by as much as 20 percent" from a single year's budget. Think about that in the context of Washington's current bitter budget battle, in which the two parties are fighting over, at most, a total of $61 billion in cuts—or just two percent of the total budget.

Few in Congress will want to slash spending or raise taxes at that level, so they'll consider other options, such as "printing lots of money, [or] partial default on the debt." And the damage could spread beyond Washington. "There is a good chance that the federal government would have to reduce payments to state governments," Kling says, "which in turn could lead to fiscal crises at the state level as well."

Last year, Kling speculated that without major policy reforms there's a reasonably high probability that the U.S. would face a debt crisis sometime in the next two decades. He's not alone in worrying. Moody's raised a yellow flag when it said last March that the U.S. was moving towards losing its solid-gold credit rating. And while the CBO would not speculate about when or if a debt crisis might happen, it has nonetheless made its basic position on the matter very clear: building up more debt means increasing the likelihood that the nation's simmering fiscal troubles will eventually blow up in all of our faces. Refusing to offer a plan is a choice to allow that to happen.