It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.
That’s generally attributed to Will Rogers, but it’s probably apocryphal.
I was going to write one post on the topic of the debt ceiling. But every time I peeled back the onion on this topic, it stank even worse. And made me cry even harder. So it’s going to take a few posts to get through this.
Like most Americans, have been kind-of laughing off the threat of a default on U.S. government debt. Default, as a consequence of failing to raise the U.S. debt ceiling.
For most of us, “It’s like déjà vu all over again.” I’m 64. Per the Wikipedia article, the U.S. debt ceiling has been increased or suspended no fewer than 86 times, in my lifetime.
So, on the one hand, how many times can the U.S. Congress cry “wolf” before nobody pays attention any more? On the other hand, recall that in Aesop’s fable, the sheep do, in fact, get eaten.
So, as is my habit, I decided to get my thinking straight about this. Like most Americans, I’m a little fuzzy on the details of just how, exactly, this whole legislated-increase-in-the-debt-ceiling works.
Personally, I’m not so much a fiscal conservative as a fiscal realist. Or, pessimist, depending on your orientation. On a personal note, I took Social Security at age 62, figuring that the current benefit levels could not possibly be sustained for much longer. And I’m taking a lot of taxable income from investments, under the assumption that tax rates cannot possibly remain where they are now.
In a nutshell, I think you’d have to be crazy not to see that we’re well into the process of the poop hitting the fan, fiscally speaking. It’s just a question of whether or not we’re going to so something rational about that. Or whether we’re just going to govern through chaos.
To cut to the chase, the more I looked, the more I realized that I completely misunderstood the basic facts of the current debt limit situation. And the less sure I was that the U.S. would avoid default this time. I’ve been sure that the problem is squarely attributable to the Republicans. And, on balance, I’m still in that camp. But now, eh, there’s an element of doubt. And that’s what I find most unsettling. Given restraints on how legislation has to get passed, it’s no longer clear to me that either party has what it will take to raise the debt ceiling.
In short, this time, I think we actually are going to default. Or, at least, run out of money. Fail to issue enough new debt to cover all currently promised payments. That doesn’t necessarily mean literal default on the federal debt. The Federal government would have no trouble continuing to make interest payments on its debt. As long as its willing to make large cuts in something else. I just have a very hard time seeing that happening.
Take that FWIW. Guard your sheep or not, as you see fit.
Instant recession: The Federal government is really, really big.
For this first post, I just want to get a few magnitudes down.
- The U.S. GDP is about US $ 23 trillion (reference).
- Total Federal spending is around $ 6 trillion (reference).
- The FY 2022 Federal budget deficit was $ 1.4 trillion (reference).
- Best guess, the FY 2023 deficit will be about the same.
So, from the get-go, realize that the Federal government is large, compared to the entire U.S. economy. From the above, Federal spending amounts to about (6/23 =~) one-quarter of the U.S. GDP.
Let me be clear, most of that spending is not, directly, itself, counted as part of the GDP.
For example, the single largest item in the budget is Social Security, accounting for 19% of the federal budget, per the U.S. Treasury. That’s a “transfer payment”. It takes money out of one pocket and puts it in another. Transfer payments are not counted as part of GDP. So those Social Security payments are not directly counted as part of the U.S. GDP.
But continuing that example, those Social Security payments are what allow a lot of seniors to (e.g.) buy food and such. And those purchase of food ARE counted in the GDP. So while Social Security itself is not directly counted as part of the GDP, you had better believe that Social Security payments fund a big chunk of what gets counted as GDP.
If we finally, truly, really hit the debt ceiling, that means that Federal spending will have to fall by roughly the amount of the annual Federal deficit. That is not, actually, 100% correct, because the increase in the public debt is not the same as the annual budget deficit. (That is due, among other things, to various Federal trust funds.) But it’s close enough.
So, how big is the annual Federal deficit, these days, relative to GDP? All things equal, if at some point the Federal government can no longer borrow money to finance that deficit, that means that payments equal to roughly (1.4/23 =~) 6% of GDP will instantly stop flowing.
Now, some of those are payments to foreigners. For example, foreigners now hold about one-third of the public debt, per the Congressional Research Service. So, about a third of interest payments on the debt go to foreigners. But that’s really a drop in the bucket. Most of that money is paid out in the U.S.
Again, some of that — like interest payments to U.S. citizens and other entities — may have a relatively minor impact on final demand for U.S. GDP. The wealthy have a notoriously low marginal propensity to consume out of current income. Just because you cut off $1000 in bond payments doesn’t mean that you’re going to see a $1000 drop in final demand for GDP.
Finally, I must note that thanks to COVID relief spending, virtually all U.S. states had record-breaking budget surpluses these past couple of years. (See Post #1316). And so, it’s not clear that cuts to payments made to states would translate dollar-for-dollar into cuts in payments that the states themselves make to others. But that would require states to pass new budgets to account for those changes.
So, let’s conservatively guess that the FY 2023 budget deficit accounts for … one way or the other … payments to U.S. entities equaling … ah, call it roughly 5% of GDP. And that if Uncle Sugar stops paying that money, then final demand for goods and services in the U.S. will drop by … ah, somewhere around 5% of GDP.
Just spitballing. It only has to be ballpark. Because we can find a credible source that says the following, emphasis mine.
Routine recessions can cause the GDP to decline 2%, while severe ones might set an economy back 5%, according to the IMF.
Source: Investopedia.
And so, if we actually go through with not raising the debt ceiling, and none of the various gimmicks for getting around that are deemed legal, and the “extraordinary measures” get used up, and payments stop flowing, we are instantly in “severe recession” territory.
That’s before any “multiplier” effects. Before the folks who didn’t get paid by Uncle Sugar stop paying their suppliers. And so on. And if those effects snowball — as classical economic theory tells us they will — it’s hard to say where that will end up.
Bear in mind, this is all before we even talk about defaulting on Federal debt or not. This is before we even recognize that the “automatic stabilizers” in the Federal budget will automatically translate that decline in GDP into an even bigger increase in the Federal deficit, vicious-circle style.
This ain’t rocket science. All I did was get a round-number estimate of first-order spending impact of hitting the debt ceiling for real. It just requires acknowledging how large Federal payments are, compared to U.S. GDP. Stopping that amount of payment, in the U.S. economy, is not something you should do on a whim. Or in a snit.
Conclusion: End of Part 1
This ended up being an odd post, because I started by researching the actual Congressional budget process. And every time I turned around, I had to go further back the chain/peel another layer from the onion. From the debt ceiling legislation, to filibuster, to budget reconciliation not subject to filibuster, to the annual budget resolution that drives budget reconciliation, to the President’s budget, to “the budget deficit”. And on and on.
And ended up with what you see above.
Just to focus on one point,the most recent increase in the debt ceiling occurred in December 2021. That was only possible because Senate Republicans agree to make a one-time exception to filibuster rules, in exchange for increasing the debt limit enough to get us past mid-term elections. This one-time exception allowed the debt ceiling legislation to pass, while simultaneously allowing all Senate Republicans to vote against it. (On paper, at least. The reality is that agreeing to the filibuster exception is what allowed it to pass.) It then passed in the Democrat-majority House. And that got us from December 2021 to where we are now.
Now, here’s where it gets frightening. I thought that the reason the Democrats didn’t take care of this again, in December 2022, when they had majorities in both Houses was, in fact, those Senate filibuster rules.
Turns out, that’s not exactly true. In theory, they could (and in the past, the Congress has) put an increase in the debt limit into annual budget reconciliation, not subject to filibuster. It’s not crystal clear that it would work but it has been done in the past. There is no precedent on whether or not members could raise “a point of order” to object to inclusion of this in the budget reconciliation bill.
But the Democrats didn’t put it into budget reconciliation. More importantly, they didn’t even try to put it there. And here’s where it gets a bit weird. The best analysis I read says that they didn’t, because if they had, the Democrats would not have had the votes to pass budget reconciliation.
Don’t know if that’s true or not. But now, with a Republican majority in the House, and a stated unwillingness to provide a “clean” increase in the debt ceiling … it sure looks to me like there’s no way to get it done. If the above is true then neither party has the majority required for a clean increase in the debt limit in the Senate. And the House is basically running amok, and on the face of it, just isn’t gonna play ball, no matter what.
Which means that neither house of Congress can (or will) get this done? That’s kind of where I ended up.
The rest of the posts in this series will now unspool in the other direction. Ending up with, how in the world is the U.S. Congress going to raise the debt ceiling, under the current circumstances? I’ve been looking at that pretty intensely for a couple of days now, and I’m still not seeing it.
