Monday, June 12, 2017
Trump is starting to draw battle lines with Congress on an issue with huge implications for the global economy
Failing to reach a deal to raise the nation's borrowing limit, however, could be disastrous for the global economy and possibly undermine large swaths of the international financial system.
"I want to emphasize that the sooner they do it, the less uncertainty there is in the market," Treasury Secretary Steven Mnuchin said of Congress on Friday.
Sooner than expected
The timeframe for dealing with the debt ceiling has crept up amid recent developments.
"I respectfully urge Congress to protect the full faith and credit of the United States by acting to increase the statutory debt limit as soon as possible," Mnuchin wrote in a public letter to House Speaker Paul Ryan when a temporary suspension of the limit expired in March.
Since then, the Treasury has used "extraordinary measures" to extend the timeframe on the debt ceiling by suspending some investments in federal retirement funds and slowing the pace of debt issuance. Originally, the Treasury and Office of Management and Budget indicated the ceiling would be hit sometime in the fall, though the exact timing is only a best estimate.
Mnuchin said recently, however, that the pace of tax receipts the department generated was slower than expected over the past few months.
"I think it’s absolutely important that this is passed before the August recess, and the sooner the better," Mnuchin told the House Ways and Mean Committee in a hearing on May 24.
On Friday, however, Mnuchin did seem a bit less alarmed, saying the Treasury has "backup plans" if the limit is not raised by August. He did not specify those plans. We will be fine if they don’t do it beforehand, but I want to emphasize that the sooner they do it, the less uncertainty there is in the market," Mnuchin told reporters at a meeting with Canadian Finance Minister Bill Morneau.
Mick Mulvaney, the director of the Office of Management and Budget, also said in a congressional hearing that the slower pace of tax collections would mean the debt ceiling could be breached sooner than previous projections. Based on Mnuchin's testimony and reports from Treasury officials, the deadline could come within the next couple of months.
Lower-than-expected tax receipts seem to be in part a problem of Trump's own making. Trump's promise to cut taxes and recent rollout of a one-page tax outline seems to be causing Americans to delay some of their tax bill in anticipation of the lower rates.
A report from the Congressional Budget Office on May 5 said tax receipts between October and April were 3% below the office's projections from January. The CBO said that could be in part due to Trump's tax promise. The reason that payments for 2016 activity were smaller than anticipated may be that income growth was weaker than expected in calendar year 2016, or that taxpayers shifted more income than projected from 2016 to later years, expecting legislation to reduce tax rates to be enacted this year," the CBO report said. Bloomberg has also reported that wealthier Americans have been deferring tax payments on non-wage income in order to take advantage of the lower rates that Trump says are on the way.
A necessary step
According to a report from Andrew Austin, an analyst at the Congressional Research Service, the idea of an official debt limit stretches back to The Second Liberty Bond Act of 1917. There has been an aggregate limit on the level of federal debt since the 1939.
Prior to this Congress, had to approve debt offerings by the Treasury on an individual basis. The debt ceiling, on the other hand, allowed Congress to exert some influence over spending and debt issuance while making it easier for the Treasury to effectively finance operations. That was especially important for bond issuances to finance American involvement in World War I. Since the debt ceiling's inception, it was repeatedly raised with little fuss — until the 21st century. Debt-ceiling fights, especially amid massive deficit increases following the 2008 financial crisis, have become more difficult and politically contentious.
Perhaps the most famous came in 2011, when it appeared that Republican leadership in the House did not have enough votes from its conference to pass the debt ceiling bill just hours before it was set to be breached. Obama, in an interview in January, called the moment the most nerve-wracking of his presidency and said he had prepared a speech in case the US went into partial default on its debt.
Obama's fear was warranted, given the massive impact failing to raise the debt ceiling would have on not only the finances of the federal government, but also the global economy.
In the most basic sense, if the debt limit is not raised the government loses the ability to pay its bills, and many elements of the federal government would shut down as obligated payments cease.
During previous debt ceiling fights, the major credit-rating agencies all said a default would lead to a serious downgrade of the US's credit rating. In 2011, the simple fact that the US got so close a breach led Standard & Poor's to downgrade the country's then-AAA rating — the first credit downgrade in the history of the nation.
Further lowering the credit rating would increase borrowing costs for the government, make issuing new debt more costly, and cause serious disruptions in global credit markets.
Outside of the effect on the US government's financial situation, the loss of faith that the America would always pay its bills would ripple out into the global economy. For instance, even the prospect of a default in 2011 caused a steep decline in US stock markets. A report on the macroeconomic effect of the 2011 ceiling fight from the Treasury Department said that the "S&P 500 index of equity prices fell about 17% in the period surrounding the 2011 debt limit debate." A 2014 meeting at the White House between the Republican House speaker at the time, John Boehner, and President Barack Obama. (Larry Downing/Reuters)
Amadou Sy, a senior fellow at the Brookings Institution, pointed out just how important the US maintaining good standing is for global investors in a post before the 2013 debt ceiling increase.
"Global investors need a 'risk-free' benchmark to value securities and US Treasurys typically play this role (given that the U.S. still holds a solid credit rating and the fact that it has never defaulted)," wrote Sy. "Emerging and developing countries that issue dollar-denominated bonds could pay a higher price should the U.S. default. Furthermore, the U.S. Treasury market is perhaps the deepest and most liquid market in the world, allowing investors to exchange U.S. Treasuries for cash very rapidly even in in times of market stress. Since the US dollar is the considered the world's reserve currency and US government bonds are key assets in much of the world's investment portfolios, undermining the world's trust in these financial products could be devastating. The Treasury report on the economic impact of such a default concluded that the failure to raise the debt ceiling would be catastrophic.
From the report:
"In the event that a debt limit impasse were to lead to a default, it could have a catastrophic effect on not just financial markets but also on job creation, consumer spending and economic growth—with many private-sector analysts believing that it would lead to events of the magnitude of late 2008 or worse, and the result then was a recession more severe than any seen since the Great Depression."
Given the necessity of raising the ceiling, the argument over the limit often becomes a battleground for various ideological arguments and politically motivated riders. This time, it has split not only Congress, but the Trump administration as well. Mnuchin, for one, has said he favors a "clean" raise — legislation solely to raise the ceiling.
On the other hand, Mulvaney has advocated for legislation that includes some spending cuts designed to rein in some of the debt increases in the future. Such a move would likely be a poison pill for Democratic support and make it difficult to pass, given the thin Republican majority in the Senate. Trump, for his part, has appeared to take Mnuchin's side, telling congressional Republican leaders that Mnuchin is "that guy" for the debt ceiling. Mulvaney's position, however, is supported by his former colleagues in the hardline conservative House Freedom Caucus — and by some in the House GOP leadership.
The Freedom Caucus, which continually pushes for debt reduction and curtailed spending, even went as far as taking an official position in May that it would not support any debt ceiling bill without concessions on spending cuts. House Speaker Paul Ryan has also said the party should target spending reductions to go along with a limit raise, but did not guarantee they would have the votes to do so.
"Yes, that can be achieved," Ryan told reporters at a press conference Thursday. "The question is can we assemble the vote coalition to do that. So, we're not taking any options off the table, we're talking with our members about what is the best way to proceed, and how can we meet these fiscal deadlines we have."
Hardline deficit hawks in the Senate, like Sen. Rand Paul, also have said they will push for spending cuts as a part of debt ceiling legislation.
Democrats have long pushed for a clean raise, and so far that is their official position. The Republican Majority should pass a clean debt limit increase and not risk the full faith and credit of the United States," House Minority Leader Nancy Pelosi said in a statement.
But given the consequences of failing to raise the ceiling and the fact that the Republican majority could feel the pressure to save face on increasing the deficit, Democrats could push for more.
The other X-factor in the debt ceiling fight this time is Trump himself.
Chris Krueger, an analyst at the Cowen Washington Research Group, said Trump's unpredictable approach to policy may bring more extreme solutions — like minting a platinum coin worth $1 trillion to pay down a chunk of the debt — to the table.
With President Trump, debt ceiling options like the Platinum Coin and the 14th Amendment — while unlikely — are now at least a possibility," Krueger wrote in a note to clients. "You also have Twitter risk, Trump's personal/business history with debt, and his comments during the election about restructuring the nation's debt (hair-cutting Treasuries?) that combine to make this a volatile DC-created tail risk."
Issac Boltansky, an analyst at the political research firm Compass Point, said there is a strong likelihood that legislators avoid a default. But given the web of conflicting policy goals, he predicted some collateral damage along the way. Odds favor lawmakers addressing the debt ceiling in advance of the deadline, but we caution that there are numerous political and practical hurdles ahead," Boltansky said in a note to clients. "Furthermore, our sense is that the accelerated debt limit timeline will further hamper the GOP’s legislative agenda, increase the odds of a government shutdown in October, and potentially shift the Federal Reserve’s policy normalization trajectory."
Asked Friday what exactly the Treasury's back-up plan was if the debt ceiling was not increased in time, Mnuchin offered only a vague assurance.
Said Mnuchin: "Treasury Secretary super powers."