Against the Ceiling

Debt crisis does look like Mad Max! - from the NY TimesThe parallels between the debt problems U.S. and Greece are generally overstated, in large part because  the workings of sovereign debt are not intuitive (here's a hint: it is not like your credit card).  There are many differences between us and them, but fundamentally they have an actual debt crisis, while our crisis only political.  They can't pay their debts, we are just blustering about refusing to pay ours.

The U.S. does not have a debt crisis, it has a debt problem.  Here is an example of the distinction. I have a weight problem: I would like to lose 10 pounds, so I should eat less and go to the gym. It would be insane to treat that like a crisis and insist that I need immediate liposuction, or perhaps to cut off one of my limbs to get to my target weight.  The U.S. has a debt problem, it should spend less and collect more revenue. Nothing to see here, no need to panic.

It is easy to tell when a country has a debt crisis because countries that can no longer service their debts all have one thing in common: high interest rates.  Because they are a high risk of default, lenders demand a premium.  Look at Greece's interest rates over the past three years:

from Bloomberg

Their interest rates have tripled in a year in a half, that's a debt crisis!

As a comparison, let's imagine what it would be like if the U.S. was dealing with Greek interest rates.  The Bipartisan Policy Center estimates that the U.S. has to roll over 467.4 billion in debt in August, if the U.S. ten year interest rates (currently 3.18%) rose to Greek levels (currently 16.26%) it would add over $61 billion to the deficit, every month.  That back of the envelope estimate is pretty sloppy - not all debt matures in ten years, for example - but that rough estimate is more than the estimated defense budget for 2012. 

So that's why Greek politicians are raising taxes and cutting spending, even though the Greeks are rioting in the streets, they have to!  When you can no longer afford to roll over your debt on the market, you can either take your medicine in the form of fiscal reform (to gain access to international agency lines of credit), or you can default.  In the long run Greece is probably gonna have to do some of both because its hard to dig out of hole (it just keeps getting bigger the more you take out...).

The U.S. on the other hand, has some of the lowest borrowing rates in the world.  In the long run, we have to balance our budgets because it is immoral to steal from future generations. However, thanks to historically low tax rates, historically high rates of spending (driven by cyclical safety net spending), and GDP knocked several trillion dollars below trend we aren't gonna balance the budget anytime soon anyway. Not to mention that 9% unemployment is our most pressing moral issue at the moment anyway.

So why is there a non-zero chance that the U.S. - considered the benchmark risk free borrower that all other financial actors are compared to - will default in a month?  Because our political system was designed not to work (we call it checks and balances), and right now Republicans are making sure it does not even function at its usual pathetic level.  

To turn a good idea into a law in the U.S. requires running the gauntlet of two houses of Congress incapable of doing anything, a President who can veto whatever squeaks out of the legislature, and a Supreme Court who can invalidate whatever is left.  Throw a hostage opportunity like the debt ceiling into the mix and suddenly we find that we can't accomplish the obvious.

If the U.S. defaults it will directly add billions to the deficit (every 1 percentage point increase in our borrowing costs adds $4-5 billion a month to the deficit), even before it wrecks the global economy, decreasing tax revenue and increasing spending on food stamps and unemployment insurance. Fighting over the debt while threatening to do something that will make it explode is insane.

So when I read that the Treasury Secretary is threatening to just ignore the debt ceiling by pretending it isn't Constitutional - well - I just don't care too much about the details.  No one mourns when the terrorist gets the gun knocked out of their hands before they can kill the hostage.