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Michael Strain on Averting the Looming Debt Ceiling Disaster
As the debt ceiling debacle continues to intensify, there are a couple of solutions that, if pursued, could help the US government avert a fiscal crisis.
Michael Strain is the Director of Economic Policy Studies and the Arthur F. Burns Scholar in Political Economy at the American Enterprise Institute and is a returning guest to Macro Musings. Michael rejoins the podcast to talk about the looming debt ceiling crisis and his recent article on the issue titled, *Averting a Debt-Ceiling Disaster.* David and Michael specifically discuss the background, history and recent events leading up to the current crisis, how to impose fiscal discipline in a low interest rate world, solutions the US government could pursue, and more.
Read the full episode transcript:
Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].
David Beckworth: Michael, welcome back to the show.
Michael Strain: Thanks so much for having me. I love your podcast and I love being on.
Beckworth: Well, it's great to have you on the show. And I want to talk about this looming debt crisis, and actually we can say we are past the looming point. Because as of last Thursday at least, we've reached the point where extraordinary measures have to be taken by the Treasury to fund US government activity so it doesn't go over the debt ceiling. But we haven't quite reached the technical default stage, which according to the Treasury, Janet Yellen would be possibly no earlier than June, according to Goldman Sachs and other private forecasters, could come by August or the fall. And you wrote this great piece that kind of summarizes the debate. You're also in Washington DC, you're feeling the heartbeat there in the imperial capital knowing what's going on.
Strain: The heart rate is increasing.
Beckworth: It's increasing. And I want to talk to you about that because there's a lot going on, talk about the history, but also just what's been happening there. So, maybe walk us through, what's the recent history, how did we get to this point where we're now again having to deal with the debt ceiling?
The Background and Recent History of the Debt Ceiling
Strain: Well, the debt ceiling is an odd feature of the process by which the US puts together budgets, so the federal government spends money. Back in the old days, Congress had to approve every bond issuance that the Treasury wanted to do. And that worked in the early decades of American history because there wasn't that much debt being issued. Then as that system became more and more of a hassle, Congress adopted this debt ceiling approach where Congress authorized the Treasury Department to issue debt up to a certain amount. Congress no longer had to authorize every issuance. And then when Treasury had hit that level of debt, it had to go back to Congress and say, "Hey, we need this ceiling increased." That also worked reasonably well. And for a long time, raising the debt ceiling really was just a routine function of government.
Strain: Congress adopted its modern budgeting process. That process has completely broken down, but at least the kind of ostensible process that Congress uses was adopted in the 1970s. And there have been some debt ceiling fiascos since then. There was a fiasco in 1979. There was the threat of the fiasco in 1995. Of course, 2011 was the worst we've ever seen. One of the consequences of the 2011 debt ceiling debacle was that the US's credit rating was downgraded by S&P. There was the threat of another debacle in 2013, and here we are in 2023. What's odd about this, Congress authorizes spending. That's our system of government. Congress passes laws that require the federal government to spend money.
Strain: Congress also implicitly determines the level of revenue by setting tax policy, and of course, tax rates and tax policy determine the amount of revenue. So, Congress is saying, here's the amount of money that the Treasury Department is legally obligated to spend. Here's the amount of money that the Treasury Department can legally collect in the form of tax revenue. If spending is higher than revenue, then the government has to borrow. And so, Congress is implicitly determining the level of that borrowing, but we still have this craziness with Congress allowing Treasury to borrow enough to cover that gap between spending and revenue that Congress itself has created. So, it's a confusing and frustrating situation.
Beckworth: Yeah, that is one of the more interesting parts of this story is that on one hand, Congress is saying spend this amount. On the other hand, Congress is saying, well, we're not sure if we're going to allow you to borrow money to pay for already existing obligations that we have put into law. So, there is this tension there. And one question I have, Michael, is does this arrangement make sense? I know it's where we are, it's what we have, but if you could wave a magic policy wand, would you eliminate the debt ceiling altogether?
Strain: Well, so I think it's actually worth lingering on a point you made in that question, because this is a source of confusion. Raising the debt ceiling does not authorize any additional spending. Raising the debt ceiling simply authorizes the Treasury Department to pay for the spending that has already happened and that Congress has already approved, and indeed that the Treasury Department is legally required to execute. Congress says, here's the law of the land. This is how much Social Security benefits will be. Congress says, this is the law of the land. This is how much our soldier, sailors, airmen, and Marines will earn every month. Congress says, this is the law of the land. This is how much money the FBI gets every month. Treasury can't just say, okay, well, we're going to spend less. Treasury is obligated to spend the amount of money that Congress has put into law.
Strain: Raising the debt ceiling does not authorize additional spending. Raising the debt ceiling simply authorizes Treasury to pay for the spending that is already in law, that Congress has already put in law. So, I think our projected spending does not make sense. We need to reduce projected federal spending. I also think we need to increase projected federal revenue. So, there is an issue here with spending and there's an issue here with revenue, and there's an issue here with debt and deficits. The debt ceiling doesn't cut spending in the future. The debt ceiling just allows you to pay for the spending you've already incurred.
Raising the debt ceiling does not authorize additional spending. Raising the debt ceiling simply authorizes Treasury to pay for the spending that is already in law, that Congress has already put in law. So, I think our projected spending does not make sense. We need to reduce projected federal spending. I also think we need to increase projected federal revenue.
Strain: To answer your question, no, I don't think this makes any sense at all. Again, the gap between spending and revenues is implicitly determined by Congress. It doesn't make any sense to require Congress to explicitly authorize these periodic debt ceiling increases. The debt ceiling puts the president and the executive branch in a weird position of picking which laws it will break and which laws it will not break. It would be illegal for the Treasury Department to issue additional debt if Congress didn't raise the debt ceiling. It is also illegal for the Treasury Department not to spend the money that it's required by law to spend. So, which of those two laws is Treasury are going to break? The 14th Amendment of the United States Constitution says that the credit worthiness of the United States will not be called into question. There's an argument that if the US doesn't honor its financial obligations, then the president in the executive branch are violating the 14th Amendment.
Strain: I'm not a lawyer, I'm not a constitutional lawyer. I can't speak with any expertise on those legal or constitutional issues. But just as an informed citizen, it just seems kind of screwy to me. And so, I think that some sort of process where when Congress passes a budget resolution or when Congress authorizes new spending, or when Congress makes changes to the budget, or sets the budget for the coming year, it should be automatically included as part of that process that the Treasury Department is able to borrow enough money to meet those obligations. And that should just be an automatic part of the process every time so we don't have to keep going through this.
Strain: There are other options too. When Democrats had unified control of government before the new Congress took over, there were a number of people who were urging them to raise the debt ceiling to 500 kajillion, bazillion dollars or some extremely large amount of money that it would take decades and decades, if not centuries to hit. That seems ridiculous on the one hand, but it's actually in my view, less ridiculous than the situation we're currently in. And so, that is another option, is to just raise the debt ceiling to some crazy high level. Really, there are a lot of things that would be more sensible than what we're going to be dealing with over the next six months or so.
Beckworth: And we'll come back to some of those suggestions. Some make more sense than others. But I'm going to go back and just flesh out this idea of keeping the debt issuance legally separate from the authorized spending and why that creates an issue. And I want to throw out an analogy that some Republicans have used, and I think it breaks down because of what you've just said. But they would say, you take a child who has a credit card and they've lived recklessly and they've spent, spent, spent, and now the credit card bill is due, that's the time for the parent to sit down with the kid and say, you need to get your spending in order before the parent pays off the bill. I think where that analogy breaks down is number one, if we're going to follow the analogy perfectly, the parent forced the kid to spend all that money.
Beckworth: Congress said, you're going to spend all these dollars on Social Security, Medicare, national defense, whatever it may be. So, it's not like the kid went out and voluntarily and recklessly spent, he was instructed on what to spend. That's the first problem with that analogy. The second one though is if you don't pay off the credit bill, there's going to be a credit risk added to that person, in this case to the US government. So, if we don't address this issue, there's more at stake than just getting our fiscal house or spending trajectories in line. I want to just go there for a few minutes. How serious should we take this? I mean, your title is, *Averting a Debt-Ceiling Disaster,* and you referenced the May 1979 incident where they had a similar debt ceiling discussion debate going on. They finally resolved it because of some computer problems. The Treasury gets the green light, go ahead and issue the debt, but because of technical glitches, they're not able to do it immediately and as a result, the financing costs go up 60 basis points. Now, that's 1979, this is 2023. Should we still be worried if we were to go into a technical default sometime this fall?
I think that some sort of process where when Congress passes a budget resolution or when Congress authorizes new spending, or when Congress makes changes to the budget, or sets the budget for the coming year, it should be automatically included as part of that process that the Treasury Department is able to borrow enough money to meet those obligations. And that should just be an automatic part of the process every time so we don't have to keep going through this.
Should We Be Worried About a Technical Default?
Strain: Yeah, I think we should be really worried about that. I mean there are some early indications that the bond market is already reacting to this. There are ways in financial markets to ensure against the risk of a US default. That currently is, I think, roughly 30 basis points. And that's the highest that's been in a long time. If you look at bonds that are maturing after the US is going to have crossed that threshold where Treasury would have to not pay bills, the yields on those bonds are already higher than the yields on bonds that are maturing before that projected time. So, you were already starting to see some indications of investors in the bond market getting concerned. As we get closer to whatever date this is, and as you mentioned earlier, Secretary Yellen is now saying it's going to be in June where the Treasury's going to run out of wiggle room and some bills are not going to get paid unless Congress raises the debt ceiling.
Strain: As we get closer to that date, let's say it's in June, you will see that bonds that are maturing in June have significant increases in their yields. That'll be obvious to anybody who looks at the charts or looks at the numbers. You will see substantial volatility in equity markets. You will see plunges in consumer confidence. You will see all sorts of bad, scary and completely unnecessary stuff. I think if Congress is able to come through at the 11th hour and raise the debt ceiling, depending on how much drama there's been, the US could receive another credit downgrading. But I would expect there to be pretty limited lasting consequences in terms of the cost facing the United States to borrow. But if you go back to that episode in 1979 where we missed some payments, I think that there are a lot of economists who think that the US borrowing costs have been higher for years, if not decades, as a consequence of that episode.
Strain: I think there are some economists who think that borrowing costs are still higher than they would've been, that we're still living with the effects of that incident over 40 years later. And so, if we actually do default, rather than Congress swooping in at the 11th hour and raising the debt ceiling, if we actually kind of go past that "X date" and if Treasury actually misses some payments, I would expect that that would have substantial consequences that would last for years and years and years, if not decades, raising the cost of borrowing for the United States, which in turn, raises the cost that you face if you want to go get a car loan, raises the cost of the interest rate on your credit card, raises the cost of your mortgage rate, and raises the costs of business transactions. Because Treasury bonds are kind of the foundation of the global financial system and are thought of as the least risky asset. If the riskiness of the least risky asset increases, then the riskiness of all other assets that are benchmarked against that asset increase. So, it's a problem.
Beckworth: I agree that it's a problem, Michael, but there's a part of me that wonders at times how big of a problem it is. And I say that because, where would these investors run to? What's the alternative? And I want to be careful in saying that. I don't want Congress to get lax because, oh well, they have no better option than treasuries even if we do screw things up. On one hand, I say that. On the other hand though, I go back to March 2020, we had to dash for cash. Treasury yields did go up. So, we do have recent evidence that things can go awry in the Treasury market and I don't want to be the person to test those limits. But there's a part of me that says, I wonder, what is the alternative? And of course, the Fed stepped in and helped calm markets. We'll come back to what the Fed could do in a situation like this.
If we actually do default, rather than Congress swooping in at the 11th hour and raising the debt ceiling, if we actually kind of go past that "X date" and if Treasury actually misses some payments, I would expect that that would have substantial consequences that would last for years and years and years, if not decades, raising the cost of borrowing for the United States, which in turn, raises the cost that you face if you want to go get a car loan, raises the cost of the interest rate on your credit card, raises the cost of your mortgage rate, and raises the costs of business transactions.
Strain: I mean, to address that, I don't think that there's much risk of the United States losing its preeminent role in global financial markets. So, I agree with you about that. It's not like the entire global financial system will be restructured around the Euro or around some other government's debt, but treasuries would be perceived as riskier, that would increase borrowing costs in the US. That's more money that taxpayers are on the hook for. Taxpayers are already on the hook for billions and billions and billions of extra dollars in payments after 2011 and we didn't default. So, there's a lot of space between… the Euro is now the bedrock of the global financial system and things would be perfectly fine, and there would be no negative consequences.
Beckworth: Yeah, for sure. And it's a great point. So, we're not going to restructure the global financial system, but it might get costlier, the one we do have. So, let's go to the real recent history and let's talk about Speaker McCarthy and how we even got to this point. Now, you mentioned the Dems in the last Congress, they could have done something, maybe not gone to 50 kajillion, but they could have at least raised the debt ceiling when they had control of both chambers. They didn't. I think maybe they were gaming this. But what has led us to this point? What did Speaker McCarthy do to get us to this situation where we are going to have this gamesmanship for the second half of the year?
The Events Leading Up to the Current Debt Ceiling Crisis
Strain: Well, Speaker McCarthy is in favor of finding a way to increase the debt ceiling and has made clear that he thinks the US should not default. But he has to control Republicans in the House and he's got a very narrow majority in the House. And so, he cannot afford to lose more than a handful of members if he wants to pass a debt ceiling increase with Republican votes. And I think the question is, what is the compromise that would satisfy Republicans in the House, that would be able to get 60 votes in the US Senate and that President Biden would be willing to sign? And that's a hard needle to thread. Indeed, it's hard to see how Speaker McCarthy can get step one of that done.
Strain: What could Speaker McCarthy put together? What compromise could Speaker McCarthy put together that would get 218 Republican votes in the House? If Speaker McCarthy starts to rely on Democrats to get a majority in the House, how many Republicans does he lose at that point? Is it tenable for him to lose 100 Republican votes and get 100 votes from the Democrats? If that's the position he's in, then I think that he will face a challenge to his speakership. And is he willing to fall on his sword and be voted out of office as House speaker in order to get this compromised through? He had a really hard time winning the speakership election even though there was no other plausible or viable candidate.
Strain: And this group of somewhere between five and 20, let's say, Republicans in the House, do not seem temperamentally inclined to make this easy on McCarthy or on President Biden, and I suspect will do quite a bit in order to increase the chaos and increase the drama around this event. There has been no clear or consistent demand from Republicans in the House. There's a vague call to cut spending. Some members of the House want that to include Social Security and Medicare. Others don't want it to include Social Security and Medicare. President Trump weighed in over the weekend and said that it shouldn't include Social Security and Medicare. What is the spending? How much needs to be cut? We have some time to work through these questions, but we don't have that much time; five months or so, if you believe Secretary Yellen. And even if McCarthy can get Republicans to agree amongst themselves, remember, that agreement still has to get 60 votes in the Senate and it still has to be something that President Biden is willing to sign. So, we're in a really precarious position, I think, because of the politics.
What is the spending? How much needs to be cut? We have some time to work through these questions, but we don't have that much time; five months or so, if you believe Secretary Yellen. And even if McCarthy can get Republicans to agree amongst themselves...that agreement still has to get 60 votes in the Senate and it still has to be something that President Biden is willing to sign. So, we're in a really precarious position, I think, because of the politics.
Beckworth: So, do you think those five to 20 members of the Republican Party, if push comes to shove, we reach that date, that technical default date, do they understand the significance of it and will they back down if there's no agreement by that time? Do they recognize this privilege we have, and we don't want to blow it?
Strain: I think that there are a large number of Republicans who don't understand the significance of this. I think that there are a large number of Republicans who don't think the consequences of defaulting would be that severe. I think that there are probably an even larger number of Republicans who think that if Treasury can pay our bondholders, if Treasury can avoid defaulting on US bonds, on US debt, then it matters even less. As long as the bills Treasury isn't paying are Social Security checks, or Medicare payments, or the FBI, or safety net programs, or infrastructure programs, or the National Park Service or whatever, as long as Treasury is keeping current on its obligations to bondholders, missing payments for those other categories of spending doesn't matter. I think that's a view that a number of Republicans hold.
Strain: And so, that, I think, is part of the problem. It's not the case that everybody agrees that there would be a real catastrophe if the US were to not increase the debt ceiling in time and the Treasury were to miss some payments. And I don't really see what's going to change minds on that issue. There are prominent Republican voices other than members of Congress that are urging that group of five to 20 members on. Larry Kudlow, Director of the National Economic Council under President Trump, for example, is saying this seems like it wouldn't be that big of a deal. And yeah, let's cut some spending.
Beckworth: Really, Larry Kudlow? I'm surprised he's making that statement. Well, let me read you an excerpt from a Washington Post article on what the House GOP would do. Now this is inside sources, and this is up for debate, but this is what they said they would do in the event they reached that technical default. We'll provide a link to the Washington Post story. But the reporters say, "In the preliminary stages being drafted, the GOP proposal would call on the Biden administration to make only the most critical federal payments if the Treasury Department comes up against the statutory limit of what it can legally borrow. For instance, the plan is almost certain to call on the department to keep making interest payments on the debt, according to four people familiar with the internal deliberations who spoke on the condition of anonymity to describe private conversations. House Republicans’ payment prioritization plan may also stipulate that the Treasury Department should continue making payments on Social Security, Medicare and veteran benefits, as well as funding the military."
Beckworth: So, they put interest payments up there. So, some of them do recognize this, but I do wonder if Larry Kudlow and others are making this statement, “ahh, it's not that big of a deal.” I'm really surprised to hear this. I recently had Paul Tucker on the show and he made this statement that a technical default would be a gift to the Chinese government. Something like that is exactly what they want, that our exorbitant privilege is something that helps pay for our defense department. It pays for things that the government does that many in the Republican Party probably cherish.
The Consequences of the Debt Ceiling Debacle
Strain: Yeah, I think that's definitely right. I think Mr. Tucker is right, I mean to say. And look, what kind of a nation are we? Are we a nation that honors its financial obligations or not? Are we a nation that tells retired Americans that you can count on X dollars a month every month and then we just don't pay that? Are we a nation that doesn't pay it's military the salaries we owe them? This would be embarrassing and humiliating for the United States as a nation. Even if we were to prioritize payments to bondholders, and even if we didn't default on any of our obligations to bondholders, we would be defaulting on our greatness as a nation, and on our credit worthiness, and on our honor as a nation if we didn't pay anybody the money that we owe you, including our own citizens.
What kind of a nation are we? Are we a nation that honors its financial obligations or not? Are we a nation that tells retired Americans that you can count on X dollars a month every month and then we just don't pay that? Are we a nation that doesn't pay it's military the salaries we owe them? This would be embarrassing and humiliating for the United States as a nation.
Strain: In addition, it's not at all clear to me that international markets would draw this distinction. It may be that if we missed payments to bondholders, that would be a huge catastrophe. And that if we kept current on payments to bondholders, but missed other payments, that would be a less huge, but still significant catastrophe. That I could believe. But my expectation is that markets would look at the US missing any payments, because Congress couldn't increase the debt ceiling, as a major event, and that that event would lead to stock prices tumbling, that that event would lead to increases in interest rates around the time that all this chaos was happening, that that event would mean the taxpayers would be on the hook for billions and billions and billions of dollars of extra interest payments, and that that event very likely could lead the US to have higher borrowing costs for years and years, if not decades. So, maybe prioritizing payments and making sure that we kept current on our obligations to bondholders would spare us the worst of what would happen if we were to miss payments to bondholders. But I think it's extremely, excessively optimistic to assume that that would avert other serious effects in financial markets for the United States.
Beckworth: So, the Treasury Department reports that since 1960 the limit has been lifted 78 times. And I know it really goes back before the 1960s to 1917, and you can add a few more in there. And so, this is not something new, as you've alluded to earlier, we've done it. It's worked well enough. But I wonder that the fact that it's becoming more of an issue, does this reflect our increased polarization in our country? In other words, this arrangement may have worked previously, but we're getting to the point where it's becoming a tool for whoever's in power to use it to accomplish their goals, their objectives, and as a consequence, we need to really rethink its use.
Strain: Yeah, I think it's a consequence of increased polarization. I think it's a consequence of increased animosity between the parties. I think it's a consequence of a larger share of members of Congress who are simply less interested in responsible governance and are more interested in kind of performative public acts. If we were to miss a payment, it would be a sign of national decline and the fact that we are flirting with missing payments, itself, is a sign of national decline.
Beckworth: The fact we're having this podcast discussion is troubling in itself. So, the key issue really is the spending itself, that we're seeing a symptom of it, this debt ceiling which can create its own set of problems. But if we want to really solve this, we got to get back to the spending as you mentioned earlier. And the biggest areas of spending, federal spending is Social Security, Medicare, national defense. And I just wonder whether any party is dedicated to making serious changes, even the Republicans, are they willing to hit those areas which are very politically important to even their own base?
Strain: Yeah, I think that's a great question. And look, before President Trump won election, I would've said yes, Republicans are committed to that. If you go back to 2005, President Bush had just won reelection and he went on a big campaign to reform Social Security in a way that would've reduced its costs. He really tried to do that. He didn't succeed, but he made a big effort to do that. Prior to that, in the 1980s, President Reagan did succeed at reducing future costs of Social Security. If you go back and look at Mitt Romney's presidential campaign in 2012, he made reforming Medicare a huge part of his campaign, to the point that he selected Paul Ryan as his running mate. And Medicare reform was one of Speaker Ryan's biggest issues.
I think it's a consequence of increased polarization. I think it's a consequence of increased animosity between the parties. I think it's a consequence of a larger share of members of Congress who are simply less interested in responsible governance and are more interested in kind of performative public acts.
Strain: And I have every reason to believe that if Senator Romney had won the White House in 2012, that he would've made that a priority. President Trump, who was elected in 2016, took a very different view on this and was very clear that he did not think that Social Security or Medicare should be cut. And again, he reiterated that view over the weekend. And a number of the more populist members of the Republican Party who are closely associated with the former president, share his view. And while he was president, reducing spending on Medicare and Social Security went dormant. And there was, I think, a bipartisan agreement that spending on those programs should not be reduced.
Strain: The big question, I think, is, what happens next? And we have a presidential system and there will be some Republicans who run for president in 2024 who favor reducing spending on Medicare and Social Security. There will be some Republicans who run who do not favor that. And whichever Republican wins will determine whether or not the party returns to its view that spending on those programs needs to be cut. It's my view that spending on those programs needs to be cut, and I think that's the view of a number of economists. There are a lot of reasonable, very serious economists who don't share that view. But I think in terms of the Republican Party and Republican politicians, it'll really depend on who wins the nomination.
Beckworth: Well, I share your view on that, it is important to get some kind of meaningful program of cuts going over the long term. It's a journey together. You can't just do sharp immediate changes. You got to put something in motion that may take decades. So, I think it's important to get someone who can do that. I'm going to turn to a question related to this, and right now we have high interest rates, which is making this issue even more pronounced. The financing costs have gone up. But it's possible, depending on your view, that rates will fall once we get to the other side of the high inflation, once we get back to true normal, if there is such a thing. So, up to February 2020, we had a really low interest rate world across the globe, and maybe we won't return to that. Maybe that's something that's a bygone.
Beckworth: But if we do, to me, this raises the issue that got us into this predicament in the first place. And that is given the structural forces around the world, the aging of the planet, things like that, that lead to lower interest rates, it makes it easier for Congress not to do anything, to not have reforms. If financing costs are low, you can continue to borrow without really feeling the constraint of a tighter budget. In fact, in some ways, you could look at Congress as using economics as endogenously responding to low financing costs. Why make tough choices if we can continue to roll over the debt, continue to get cheap financing? And so, let's imagine a world, Michael, where we go back to that. So, in fact, let's go back to the 1980s, 1990s, where we're always getting warnings, “oh, the debt's unsustainable,” all these warnings, and we're at a place now where it seems even more so than ever. But what if we go back to a low interest rate world where this is less of an issue, the size of the debt is less consequential, the trajectory becomes less consequential. How do we impose fiscal discipline in that world? What do we do given the incentives that low financing costs creates for Congress?
The big question, I think, is, what happens next? And we have a presidential system and there will be some Republicans who run for president in 2024 who favor reducing spending on Medicare and Social Security. There will be some Republicans who run who do not favor that. And whichever Republican wins will determine whether or not the party returns to its view that spending on those programs needs to be cut. It's my view that spending on those programs needs to be cut, and I think that's the view of a number of economists.
Fiscal Discipline in a Low Interest Rate World
Strain: Well, I think it's both harder to impose fiscal discipline in that environment, but also I think less necessary. I think there's a lot of confusion around this issue, and it's a contentious issue to be fair. But in my view, even in the kind of low interest rate world that we were in, in the run-up to the pandemic, there was still crowd out, by which I mean large government deficits still had an effect on reducing private investment. That's not a good thing. The more private investment you have, the more productive your workforce is, the higher wages are over the longer term. The size of the debt, I think, creates challenges for responding to emergencies and extraordinary situations.
Strain: I'm not going to remember which chairman of the Joint Chiefs of Staff said this, but at some point in, I think, the decade prior to the pandemic, one of the chairman of the Joint Chiefs of Staff cited the national debt as one of the biggest national security risks facing the United States. And a lot of that debt is held by foreign entities. And even given the low rates that we enjoyed prior to the pandemic, if you took a 30-year outlook or certainly a 50-year outlook, the gap between projected spending and projected revenue was so great that you would still be in a situation where you would be paying more, where the US government would be paying more every year in interest payments to bondholders than we would be paying on national defense, where the level of debt relative to annual GDP would be growing and growing and growing and growing and growing to a point where I don't think many economists would be comfortable.
Strain: And so, even in the low interest rate world that we had before the pandemic, the following year… we didn't have a problem over the following five years. We still had a problem with the 30-year outlook, certainly still had a problem with the 50-year outlook. And in order to address the 30-year outlook, in order to address the 50-year outlook, it's really important to phase in reductions in future spending very gradually, in order to cause the least disruption possible to people who are receiving Social Security payments, who are receiving Medicare benefits, and who are expecting to receive benefits from those programs in years to come. So, the ideal situation is to do very small adjustments over time that avert that problem that's 30 or 50 years out. By waiting, you're making that problem worse and you're really hurting the people who are planning on using those programs. If, on the other end of the inflationary episode we're experiencing now, we don't return to a very low interest rate world, all those problems still exist. They just become more urgent and immediate. In my view, if we do return to a low interest rate world, all those problems exist, it just takes 20 or 30 years for them to manifest rather than five to 10.
Beckworth: Let's circle back to the debt ceiling issue itself. That's what motivates this conversation. You have this article, *Averting the Debt-Ceiling Disaster,* and in it you provide two solutions, I believe, moving forward. The first one we've touched on already, that is that President Biden and his administration should take seriously, some negotiations with the Republicans. They need to actually acknowledge that they can't do what they're doing now and just say, we're not going to negotiate. They actually have to engage and try to work out a deal. But you propose a second option, and that's a discharge petition. So, walk us through that. How would that work?
Solutions to the Debt Ceiling Disaster
Strain: Well, I'm not an expert at parliamentary procedure, but the idea here is that the House of Representatives can vote on a particular bill without the speaker affirmatively bringing that bill to the floor. And that requires a whole bunch of things to happen, but it's something that's possible. There are still enormous challenges with this. Obviously, in terms of process, whatever passed the House using a discharge petition would have to be acceptable to 60 senators and would have to be acceptable to President Biden. That's a pretty high hurdle. In addition, the option of using a discharge petition, which again would allow the House to vote on raising the debt ceiling without requiring Speaker McCarthy to bring a bill of that effect to the floor, would almost surely have very little Republican support.
Strain: And the Democrats don't want to do this on their own. That's why they didn't do it when they had unified control of both houses of Congress and President Biden in the Oval Office, because they don't want to do it on their own. They don't want Republicans to be able to say the Democrats are the party of higher debt. They don't want the Republicans to be able to say, the Democrats increased the nation's credit card limit, and we didn't participate in that. They did it on their own. They're the party of more debt. And I think there are enormous political challenges, even to the discharge petition option, because so few Republicans would go along with the Democrats who would be the motivating force behind that. It could be that we look back on President Biden and the Democrats' decision not to take care of this before the current Congress was sworn in, as one of the most important decisions of his presidency.
And I think there are enormous political challenges, even to the discharge petition option, because so few Republicans would go along with the Democrats who would be the motivating force behind that. It could be that we look back on President Biden and the Democrats' decision not to take care of this before the current Congress was sworn in, as one of the most important decisions of his presidency.
Strain: That should tell you a lot about the politics of this. The White House understood the risk here. And the White House may have been surprised by how difficult it was for Speaker McCarthy to secure the speakership. So, I'm not saying that they fully understood the risk, but they certainly understood there was a risk after the outcome of the midterm elections had been decided, and even before that. And they chose not to act because they wanted this to be a bipartisan effort. That basic political situation still remains. And so, an option that doesn't involve Republican participation in the House is going to have very limited appeal to Democrats in the House, and I think to the White House. Of course, that gets us back to the problem, which is that an option that does involve Republican participation in the House, is also a very difficult needle to thread. So, again, it's a challenging situation.
Beckworth: Well, let's look at some other options. And I want to circle back to the extraordinary measures that are being done right now just so our listeners have a clear idea of what that is. So, I'm reading from a Bipartisan Policy Center brief. And they go through the main ways that Treasury can do this. And essentially, they're looking at these government investment funds that have treasuries, and these are one day treasuries. And basically, the US Treasury Department can choose not to issue debt, roll it over, and that frees up some space for the kind of accounting maneuvers they're doing now. But that will only take us so far as you mentioned earlier. So, the other big player in this is the Federal Reserve. And we mentioned earlier how the Fed stepped in in March 2020 when there was a dash for cash and the Treasury market was under stress.
Beckworth: And if we go back and look at 2013, there's actually a huge discussion about this at the FOMC in October, FOMC meeting, and they actually had a list of things they could do. They spelled out some specific things they could do, and they ranged from treating defaulted treasuries as good as non-defaulted in their interactions with the marketplace. So, they wouldn't lose any standing there. They could also actively intervene. They could step into money markets, do reverse repos, open up the discount window or a standing repo facility, do things to make sure that the treasuries out there are still treated and viewed as fully functional. And at the end of the day, they could go real extreme and just take some of these defaulted treasuries and put them on their own balance sheet. They could buy them up and that would be very risky. And they understood this.
Beckworth: And it's interesting that Chair Powell was then just a governor. And if you read some of his discussion, he has this tension he's worried about. He says, on one hand, we need to maintain financial stability. That's one of the mandates Congress has given us, also price stability, but there's a financial stability part of the Fed's mandate. On the other hand, if we stick our necks out and say we're going to do this explicitly, it emboldens Congress to delay the decision, to kick the can down the road, may also come across as we're being politicized, we're going to step in and bail out the Treasury market. So, there's a tension between the Fed saying, “hey, we got this,” versus let the political players sort it out. Any thoughts you have on that?
The Prospect of Fed Intervention
Strain: Yeah, I guess I have two thoughts. My first thought is that the Fed likely would not plan on actively subverting the will of Congress. And the Fed, I think, would likely not plan on bailing Congress out, so to speak. My second thought… and I think that would be appropriate if the elected branches of government decide to default on US debt, which would be what would happen. Nobody would be voting for default, but by not coming together and figuring it out, that's a decision. If the elected branches of government decide to default on the US debt, it is not the job of the Fed to ignore that decision and to treat bonds that are in default as if they are not in default. And I think the Fed would rightly be worried that if it were to do that, then there would be pretty substantial ramifications for Fed independence and congressional oversight of the Fed and changes to the Federal Reserve Act and all sorts of things that would fall out after that.
Strain: My second thought is that it's really hard to know what would happen and who would do what, because if the US were to miss payments to bondholders, there would be complete chaos in financial markets. And the chaos of that moment, I think could dictate actions and could lead to preexisting plans being thrown out the window. What I think would probably happen is that, so say the US misses payments to bondholders that are due on Monday, Monday's the first day. We're fine on Friday, on Monday payments are due, and the debt ceiling hasn't been lifted, and Treasury doesn't make those payments. The Dow drops by thousands of points. There's widespread condemnation of the United States government. Overnight opinion polls show Congress's approval rating is plunging towards zero.
Strain: And the next day or maybe the day after, a clean debt ceiling increase passes both houses of Congress with overwhelming bipartisan support. That's, I think, the most likely scenario. And so, under that scenario, there's just not time for the Fed to be setting up facilities to handle this and to do all that sort of stuff. And the Fed is, I think, kind of let off the hook by that political dynamic. Quite similar to what happened with TARP, where TARP didn't pass Congress and then there's a huge financial meltdown, and then the next day TARP passed Congress. I mean, I think that's what would happen. I don't think that the worst case scenario here is not a scenario where for weeks or for months, the US isn't keeping current with bondholders. I think that's just so unbelievable to me. I can't imagine that would happen. But even being in default for one or two days, I think has long lasting consequences to US borrowing costs to the US taxpayer and to America's standing in the world.
I don't think that the worst case scenario here is not a scenario where for weeks or for months, the US isn't keeping current with bondholders. I think that's just so unbelievable to me. I can't imagine that would happen. But even being in default for one or two days, I think has long lasting consequences to US borrowing costs to the US taxpayer and to America's standing in the world.
Beckworth: That's interesting. So, you think that if we went one day, that'd be enough slap in the face to Congress to get their act together and pass a bipartisan bill to raise the debt ceiling?
Strain: One day, maybe two.
Beckworth: Two, okay. A few days of intense scrutiny from the markets and from the world would quickly put them to shame.
Strain: And billions of dollars of wealth evaporating.
Beckworth: That's a good wake-up call for sure. In the time left, let's look at a few other suggested solutions, ones that I suspect you won't endorse, neither do I. And I'll start with one from John Cochrane, great guy. And he even said, this is a bit of a joke or just for fun, maybe financial engineering your way out of the debt ceiling. And that's the issue of perpetuities or coupon only debt, because the law says the debt ceiling is based on the face value of government debt. So, if you issued a coupon only debt or perpetuity, so it only pays interest, well, wow, your problem is solved.
Strain: Yeah. John's an excellent economist for sure. And if I remember correctly, he said something like he was proposing that option just for fun. And it's an interesting academic thought experiment. I mean, I think the market reaction to that would be quite negative.
Beckworth: Right. So, any of these proposals we're going to go through at this stage of the discussion are going to be ones that probably would generate as much problem as having an outright default.
Strain: Or close to it.
Minting the Trillion Dollar Coin
Beckworth: Or close to it at least. I mean, because it would undermine the institutional norms of the US government. And I think that itself would create rule of law questions. So, let's go to the next one, and that is mint the platinum coin. So, there's a law that some argue makes it legal for the mint to have a platinum coin with the face value very different than the actual value. So, make it a trillion dollars and the Treasury would go deposit it at the Fed’s TGA account and the Fed would have to credit. And there's debate how legal is it. Some say, well, it's completely legal. Others would say, well, it may be legal to mint the coin, but the Fed would not take it, it would not accept it. And then some of the advocates say, well, the Fed should, they're the fiscal agent of the Treasury. Janet Yellen has come out against it. Most people have come out against it. The Biden administration has said, we would not want to do this because, if we pushed it and the Fed said no, then it'd go to the Supreme Court and there'd be all kinds of repercussions. This kind of institutional norm challenge that would probably be very consequential to markets, not quite as much as the default, but close to it as you mentioned. So, what are your thoughts there?
Strain: Yeah, I mean, agree with your skepticism. I think this is frankly one of the silliest public policy proposals that I've encountered in the last decade, and that's really saying something given how the last decade has gone. I mean, I think you identify the problems with it. Obviously, the intent of Congress was not to allow the Treasury Department to run a printing press of unlimited amount. We have a system of laws, including the Federal Reserve Act, that set out how the US money supply is created and managed, and this is not part of that system. And everybody knows that, including the Supreme Court of the United States and including the Fed. I think it would be very difficult to believe the Fed would take that trillion dollar coin and allow the Treasury to spend it. I mean, how does it even get delivered? Does the Treasury secretary walk to the Fed building with the coin in her pocket and hand it to someone? What happens then? So, the Fed would not accept it. It certainly should not accept it. The mere act of minting it, I think it has to be minted, the mere act of minting-
Beckworth: So, physically minted.
Strain: Physically minted, exactly. The mere act of physically minting it would create a huge amount of chaos in financial markets. The stock market would plunge. And when the Fed said no, that would be another major market event. The Supreme Court can act pretty quickly, but it usually takes at least a day or two. And there would be absolute chaos in that day or two. During that period, a debt ceiling increase would pass both houses of Congress with bipartisan over support. And when the court's ruling was published, obviously, well, not obviously, I mean shouldn't say, obviously, I'm not a lawyer or an expert on the Supreme Court.
Beckworth: Seems likely.
Strain: It seems likely to me that the Supreme Court would not allow that. So, yes, a bad idea.
Beckworth: Yeah. And recently Josh Barro made another argument I hadn't thought about, but it complements what we've been saying, and that is if this did go through, if the Supreme Court did approve, somehow it got pushed through and was successful, it would really undermine the regime that we have, the system we have. And it could really unanchor inflation expectations. If we can do a trillion dollar coin now, why not in the future? It would really unmoor inflation expectations and lead us to a path where we would have to really wrestle with inflation taking off again. So, it's not just about the decision today, it's the precedent it could set for the future.
Strain: It's the precedent that it could set for the future, but I think there's an even deeper problem than that. The fundamental issue here is whether or not the United States is a nation that honors its financial obligations, and whether or not the United States government is functional enough to honor its financial obligations. There are governments that are not functional enough to honor their financial obligations. That is something that happens over and over again in history. Is the United States one of those governments or are we a government that does honor its financial obligations? Any gimmick that we would use to get through this current crisis would need to communicate to markets and to investors and to foreign governments that the United States remains a nation that is functional enough to honor its financial obligations.
Any gimmick that we would use to get through this current crisis would need to communicate to markets and to investors and to foreign governments that the United States remains a nation that is functional enough to honor its financial obligations.
Strain: If we got out of this situation with a platinum coin or with a coupon only bond or whatever, that would not be what would be communicated. What would be communicated would be something very different than that, that the US Congress and the president of the United States were unable to get this done. And that's what matters. That's what would matter. Platinum coin, no platinum coin, whatever, that's the underlying issue, and that's the challenge that is before the Congress of the United States and the president of the United States right now.
Beckworth: Well, on that important and sobering point, our time is up. Great way to end there, Michael. Thank you again for coming on the show.
Strain: Thanks so much for having me. It's always great to be on.
Photo by Stefani Reynolds via Getty Images