TILL DEBT DO US PART

With about 6 weeks remaining before the ability of the U.S. Treasury Department to prevent U.S. national debt from exceeding the debt limit is exhausted, the prospect of a simple resolution to the problem - increasing the debt ceiling - dims with each passing day. The Republican Party insists on significant budget reductions as the price for increasing the debt limit. The Democratic Party has tried to separate the two issues by dividing the debt problem into short-term versus long-term problems. Conflation of the two types of debt problems aids the Republican Party's attack on Medicare and Medicaid, while the position of the Democratic Party suggests that it has no real plan to attack the increasing debt level. What is lost in the discussion is an historical perspective, one dating back to the late 1940s at least. Which party can be trusted to actually do something about the national debt?

Unsurprisingly, to this blogger, at least, the Democratic Party historically has reduced the public debt as a percentage of GDP when it has occupied the White House. The Republican Party - since the Reagan era - has added to the debt by leaps and bounds and has pushed the debt ever higher as a percentage of GDP. While it is true that initiatives such as FDR's and Obama's to reverse a sinking economy added to the budget defict, the gamble (and hope) was that increased economic activity would stimulate the economy and enhance government revenues so that in the long-run economic stimulus would not contribute to a permanent increase in the national debt. FDR's initiatives might well have succeeded had not the mini-recession of 1937, brought on when concern over the national debt caused FDR to reign in budget deficits caused the economy to stall. World War II rescued the economy as the America was mobilized to fight a two front war. While the 2 1/2 wars waged by Obama might seem comparable, these wars of choice have been so compartmentalized that their stimulative impact has been marginal.

Like the fate of the economy after FDR's retrenchment in the face of deficit (1937), the economy appears to be sputtering. The stimulus of 2009 and 2010 is now a spent force. Though many economists prefer a new round of stimulus, it is extremely improbable that such fiscally based stimuli would have any chance in the Republican controlled House of Representatives where any fiscal stimulus legislation would have to originate. At best, we might hope for tax incentives of the sort that saw the continuation of Bush era tax cuts, principally for the benefit of the wealthy, coupled with payroll tax rebates designed to put more money into wage-earner hands, money that has the advantage of being spent immediately as opposed to being socked away in savings accounts.

As a stimulus, the tax deal struck during December 2010 is probably a non-factor. The continuing lack of demand from a stagnant and in some areas still declining housing sector has been a big drag on the economy. The debt overhang for many wage-earners more than nullifies the stimulative effect of a few more dollars in net wages as families seek to reduce personal debt. The temporary increase in food and energy costs has further diminished the stimulative impact of a few dollars more.

Worse: the tax deal aggravates both the short-term and long-term deficit problems. In the short-run, it reduces government revenues. As a percentage of GDP, government revenue has been reduced to that of the Eisenhower era, an era pre-dating Great Society social spending. In the long-run, if the Bush era tax cuts are continued, the job impacts will remain negligible and the drag on government revenue palpable. In addition, by taking money from Social Security (to finance the payroll cut) the long-term deficit of Social Security is marginally affected.

In the meantime, QEII is ending. This monetary stimulus probably helped prop up the mortgage market by keeping mortgage interest rates lower than they otherwise might have been. And, it did stimulate American exports by causing the value of the dollar to fall (and aggravating trading partners). Fed Chairman Ben Bernanke has dismissed the prospects of further monetary stimulus by the Fed as highly unlikely.

While one might view the debt debate in the US as a highly partisan affair that amounts to nothing more than a tempest in a teapot, it is disturbing that this rancorous debate coincides with the on-going attempt to renegotiate Greek debt in order to prevent a sovereign debt default in the Eurozone. Failure to reach an increase in the US debt limit might technically lead to a default here, but is unlikely to. The US Treasury might well maintain the good faith reputation of US government debt by continuing to pay interest to Treasury bondholders. It could delay payments to vendors doing business with the US government and delay payments to Social Security recipients and to doctors and hospitals in order to avert an across the board default. Still, a Greek default and the likelihood of increased debt difficulties for the remaining PIIGS within the European Union would add stress to international finance that could well impact the United States. At the very least, it could lead to a rush of investors into US Treasury bonds and thus maintain the near zero coupon rates that Treasury has been able to maintain since 2009. This would help banks, already larger than when they were too big to fail, to muddle through despite the presence of toxic assets still on their balance sheets and the decline of bank stocks in general. On the other hand, it could lead private investors to hoard money and demand higher interest rates from many debtor nations, including the US, and thus aggravate the short-term debt burden by increasing interest payments on the debt.

What is to be done? The obvious need is to increase the debt limit in the United States as soon as possible. Some have argued that this should be increased to accomodate the desired, but at the moment politically impossible, Ryan tax cuts to the wealthy. The sooner the debt ceiling is raised, the better. But, Tea Party nonsense, the conflation of short and long-term debt by Republicans motivated by a desire to dismantle Medicare and Medicaid, and the craven inability of the Obama Administration to dig in its heels and speak truth to propaganda do not augur well for immediate resolution of the debt ceiling issue.

One scenario that might play out is the following: a Greek government increasingly rocked by widespread protests against austerity cannot push through a second round of austerity legislation. The EU balks at renegotiating Greek debt, but cannot swallow the damage to French and German banks if Greece were to default. The inability of the EU to act decisively increases the pressure on the remaining PIIGS as interest rates rise with respect to the rollover of short-term government bonds. The United States treasury is negatively impacted as well as it is forced to pay higher interest on short-term government roll-over bonds. Shorting European and American bank stocks may well ensue in order to shake out weak and weakened financial institutions. Combine this with shorts on credit default swaps and we could find ourselves back to square one. But, would a Republican House of Representatives, reluctant to pass an increase in the debt ceiling, have the courage to bail out the banks again?

What can be done? Not much if you don't have much at stake. Too many Americans have no skin in the game because they are excluded from credit markets. To the extent that Americans used their home equity as an ATM to pay down credit card debt or finance extravagant spending, such people have no stake in finance today because the ATM is out of service. Others are so far underwater in their mortgages that there really is no need to worry about further decreases in equity. True, some homeowners might fear a new wave of foreclosures as banks push foreclosures harder to meet their own capital demands. Yet, the foreclosure is fraught with delay in large measure due to the lax paperwork procedures tolerated and encouraged during the mortgage securitization boom of the early 00s. Unemploymnent might be a worry, but many large companies have enough cash on hand to weather another international financial crisis. Thus, a new round of massive layoffs probably will not ensue immediately, if at all.

What is needed is a revolt against Reagan era policies that have led to a widening gap between the rich and superrich classes as against an embattled middle class. Until we put an end to financial machinations that have seen the growth of ever more complex financial instruments that serve no apparent social utility other than to stick some unsuspecting investor or class of investors with the financial downside of casino style gambling. A new round of bank bailouts ought to lead to bank nationalizations and the breakup of mega-banks and the elimination of compensation systems that reward incompetence and feed otherwordly expectations for bonuses.