We're Gonna Need a Bigger Belt

Sometime next year, probably before summer, total federal government debt will reach its Congressionally-set limit. In theory, that could cause the government to be unable to pay its bills, and to default, or come near to default, on its debt. At that point, at lot of folks in Congress, as well as policy braniacs all over Washington, will push to do what Congress usually does when the legal debt limit appears in sight: Vote to raise the debt limit, yet again. It's a lot like the belt-loosening ritual familiar to just about anyone who's ever continued to gain a lot of weight over a long period of time. Eventually, you just give up and admit to yourself that the looser notch is the new normal, and you'll never tighten it quite as much again.

The problem this time around is that a number of freshmen Republicans ran on anti-spending, anti-debt campaigns, and they're not sure they can support yet another hike in the debt ceiling. And if not enough Congress critters go for raising the limit, then there just might be a government shutdown. Just like vampires need blood to survive, Washington needs debt to keep working, or so the theory goes.

Paul Krugman, for example, warned just yesterday that thanks to GOP stubbornness, numerous public services could be at risk. "It's hard to see how this situation is resolved without a major crisis of some kind," he wrote. Isn't it plain to see that ever-rising debt is as American as apple pie, that good government and more debt go together like peanut butter and jelly, that it is our manifest destiny to continue taking out loans on the taxpayer's tab until government borrowing has utterly transcended cliche?

Clearly, Krugman is laying the groundwork to blame debt-skeptics when the the issue starts to make bigger headlines next year. But it's worth looking at what's really going on. First, there's little indication that most Republicans will simply refuse to raise the limit, period, no dealing. That may be the case for some freshmen, but it's doubtful that a flat refusal will end up being the primary Republican position. Presumptive House Majority Leader John Boehner is already indicating that he'll work to ensure that it's raised. And even the eternal foes of expanding government revenue at Grover Norquist's Americans for Tax Reform have agreed that "no one, regardless of who is in the majority, wants to see the US default on its debt." Instead, Republicans will probably attempt to pitch Obama and the Democratic party a sort of bargain in which Democrats agree to significant spending cuts and Republicans go along with an increase in the debt ceiling. If Democrats won't agree to those terms, and government operations go through a rough patch, will it really be entirely the GOP's fault for refusing to raise the ceiling?

So you can probably count on some serious debt-related drama as the debate grows. But it's also worth noting that, as The Manhattan Institute's Josh Barro wrote earlier this month, it's not clear that a drawn out battle over the debt limit actually would lead to a default or a government shutdown.

The consensus view seems to be that a debt limit impasse will lead to an acute crisis: at least a government shutdown, possibly a failure to make interest payments on government bonds, and an ensuing spike in bond yields and fall in stock prices. The urgency of the crisis would make it self-limiting, one side would quickly cave, and Congress would approve a debt limit increase.

I think another scenario is at least as plausible: failure to raise the debt limit could lead to a prolonged standoff, with the Obama Administration using financial strategies and accounting gimmicks to stay technically within the limit and continue operating the government. In doing so, the Administration would draw on plans created when the federal government hit the debt limit in 1995, and essentially copy tactics that are regularly used by illiquid state governments. Obama and the Congress could muddle through for months or, theoretically, years without a debt limit increase, and without an acute crisis in the bond markets.

Barro's column lays out a host of strategies that might allow the Obama administration to proceed temporarily without either raising the debt limit or shutting down the government, and it's worth reading in full. But the key points he makes are that previous governments have made provisions for the possibility of a debt-limit showdown, and previous battles over the debt ceiling didn't actually trigger significant market panic. Instead, markets remained confident that the U.S. would eventually find a way to pay its bills, presumably by reaching an agreement to allow the borrowing to continue somehow or another.

This is one of the consequences of allowing the government to take a lax attitude toward debt for years on end. In the near term, lifting the debt ceiling may be inevitable.

All of which is to say that you can probably expect Washington to go ahead and loosen its belt another notch once again. The important question is whether it will also agree to go on a diet as it does.