Tracking the debt ceiling debate has been something of a monumental task – there are simply too many pieces in motion at any given time. Perhaps even more of a challenge given that it is an insider’s game, and I am well removed from that game Indeed, from my perch the only thing that looks certain is that whatever happens will be unambiguously bad for the economy. We are simply looking at degrees of bad – fiscal contraction in the range from mild to severe. The latter – a severe contraction – will almost certainly result if federal spending needs to be slashed beginning next month to maintain servicing the debt, thus preventing defaults to one group of creditors while defaulting on promises to another – the general US public.
One view is that the consequences of failure are so severe that failure is not an option. Thus, we are simply watching a political spectacle unfold that will ultimately be resolved. In other words, you can sleep peaceful dreams throughout the weekend.
I wish I could be that confident.
Here is my view from the other side of the continent: My fear is that this optimistic assessment fails to sufficiently acknowledge there are two battles. One between Democrats and Republicans, and the other within the Republican party itself. And any outcome that is acceptable to Democrats is internally corrosive to Republicans. So internally corrosive that compromise with Democrats is a monumental if not impossible challenge.
Consider Paul Krugman’s analysis:
There’s actually a simple way to resolve the debt ceiling crisis: non-crazy Republican leaders could support something like the Reid plan — which is, let’s be clear, a huge victory for the right and defeat for progressives — and pass it with limited GOP support and overwhelming Democratic support. Situation resolved.
This would, however, probably be the end of these Republicans’ political careers. And the answer is, so?
If you believe that default will quite possibly be a catastrophe — and leading Republicans probably do believe that — their unwillingness to take the action I’ve just described means that they are risking America’s future rather than pay a price in their personal political careers. That’s cowardice on an epic scale, even if it’s the kind of behavior we take for granted nowadays.
On the surface, the Reid plan looks like an overwhelming defeat for progressives, but a look deeper suggests that it arguably puts the Democrats in a much stronger position in 2012. Ezra Klein:
Democrats are going to lose this one. Whatever deal emerges to raise the debt ceiling, we can be pretty sure it won’t include revenue, it won’t include stimulus, and it will let Republicans pocket a trillion dollars or more in cuts without offering anything to Democrats in return.
It’s difficult to see how it could end otherwise. Virtually no Democrats are willing to go past Aug. 2 without raising the debt ceiling. Plenty of Republicans are prepared to blow through the deadline. That’s not a dynamic that lends itself to a deal. That’s a dynamic that lends itself to a ransom.
Yet Democrats will have their turn. On Dec. 31, 2012, three weeks before the end of President Barack Obama’s current term in office, the Bush tax cuts expire. Income tax rates will return to their Clinton-era levels. That amounts to a $3.6 trillion tax increase over 10 years, three or four times the $800 billion to $1.2 trillion in revenue increases that Obama and Speaker John Boehner were kicking around. And all Democrats need to do to secure that deal is — nothing.
The Reid plan raises the debt ceiling by enough to clear the next election, sufficient to take it off the plate next year. Which leaves the Administration holding the leverage – that’s a nice little tax break you have there, you wouldn’t want something to happen to it, would you?
If the Republicans are able to keep the debt-ceiling debate alive, however, they at least have some hope of holding onto some leverage in 2012, keeping the debt-ceiling/revenue/spending dynamic in play. After all, as Klein noted, a greater proportion of Democrats believe the debt ceiling is meaningful – which provides the Republicans with leverage. If the Republicans give up the debt ceiling now, they lose that leverage when it comes to the election year tax debate.
In other words, if the Republicans cave and give the Administration enough rope to raise the debt ceiling either all in one swoop or piecemeal over the next 20 months, continuing the Bush-era tax cuts becomes a more difficult game, as they simply expire without the signature of President Obama.
And, if the Republicans do cave, the internal politics become unbearable. As Krugman noted, some political careers may end. But it is worse than that – I think it throws the party into turmoil as the Tea Party contingent digs in their heels and forces the party to move much, much farther to the right ahead of the 2012 election, while Obama gets to move to the center. All of those “pledges” not to raise taxes or raise the debt ceiling come back to haunt the party all next year.
In the meantime, the Administration can’t cave and make a deal that brings the debt-ceiling debate back to life before the elections. Why? I suspect the Administration is mollifying Congressional Democrats with the promise that tax revenues will take a front seat next year, once the leverage of the debt-ceiling is removed. If the Administration caves, the election-year debate is not as favorable for the Democrats and, perhaps worse, gives the Republicans time to regroup. The whole fight was for nothing – Congressional Democrats will be enraged.
It seems that, although there is a lot of griping that the Administration and/or Congressional Democrats have messed up big time, the Democrats are really squeezing the Republicans hard. Perhaps too hard, some might say, as a non-trivial contingent of Republicans are just that sort of crazy that makes them think not raising the debt ceiling won’t be that bad (the relative calm in financial markets only further bolsters such faith). And they will viciously attack any Republican who sides with a Democrat plan. Leaving it a real possibility that Congress can’t pull together a solution unless Democrats cave on the timeline. Which they can’t do – which means they, or the Administration, must be willing to put the US economy at risk.
And this is where is gets even more interesting – how many eggs is Obama willing to break to make this omelet?
Brad DeLong, for instance, wonders why the Administration can’t use technical fixes to ignore the debt ceiling limitation. Or why not just invoke the 14th Amendment? I think the answer is that Obama believes he can manage the pain – make it clear that he will abide by the wishes of a Republican-controlled House and not breach the debt ceiling, but the country will have to live with the consequences.
The trick here is to ensure the blame for the ensuing slowdown falls relatively harder on Republicans And the survey data suggests this is exactly what is happening. By this mechanism, the Republican party is torn apart by public opinion.
So, it seems to me the Administration has the Republicans in a heads I win, tails you lose situation. They will have to eat something that tastes very, very bad, and as a consequence, bear tremendous pressure from either the inside and the outside. Either way, Obama ends up looking like the reasonable centrist who can keep his party in line. To pull it off, Obama just has to be willing to endure the pain of a further economic slowdown, hoping to make it up on the other side. And note this – it seems this Administration is willing to bear a remarkable amount of pain. Notice the unemployment rate lately?
All of which leaves me thinking there is a very nontrivial chance the debt-ceiling question does not get resolved by August 2. But I admit that this is just my West coast, outsider view that has emerged from studying the news stream of East coast insiders, and will be happy to see the expected compromise emerge over the weekend.
This post originally appeared at Tim Duy’s Fed Watch and is reproduced here with permission.