Let's face it, Americans do not understand the current state of either macroeconomic policy or foreign policy terribly well. According to Bloomberg, only six percent of Americans know that the federal budget deficit is actually shrinking. According to Gallup, just a bare majority of Americans believe that the United States military remains "number one in the world militarily." In a world of these kind of epic media fails, where significant numbers of GOP legislators seem "more concerned about 2% inflation than 8% employment," it's important to to have recognized experts try to clear the air.
Nobel Prize-winning economist and unusually-pithy-writer-for-an-economist Robert Solow has an op-ed in today's New York Times to offer a primer on the implications of U.S. debt. Here, in brief, are the "six facts about the debt that many Americans may not be aware of," in Solow's words. Let me number them here:
1) Roughly half of outstanding debt owed to the public, now $11.7 trillion, is owned by foreigners. This part of the debt is a direct burden on ourselves and future generations....
2) The Treasury owes dollars, America’s own currency (unlike Greece or Italy, whose debt is denominated in euros)...
3) One way to effectively repudiate our debt is to encourage inflation...
4) Treasury bonds owned by Americans are different from debt owed to foreigners. Debt owed to American households, businesses and banks is not a direct burden on the future....
5) The real burden of domestically owned Treasury debt is that it soaks up savings that might go into useful private investment.
6) But in bad times like now, Treasury bonds are not squeezing finance for investment out of the market. On the contrary, debt-financed government spending adds to the demand for privately produced goods and services, and the bonds provide a home for the excess savings. When employment returns to normal, we can return to debt reduction.
Some foreign pollicy experts think that Solow is being too sunny. Take Council on Foreign Relations president Richard Haass:
With respect, I think Solow is actually being too pesssimistic, and Haass is being way too pessimistic.
The problem is that, contra Solow, I suspect Americans are keenly aware of his points 1-5. The United States owes a lot of money to China, but I'd wager that any poll of U.S. citizens would reveal that the public thinks we owe even more to China than we actually do. Similarly, much of the policy rhetoric coming from Washington focuses on fears of incipient inflation that have yet to pan out.
It's Solow's last point that is the one Americans need to hear more: in an era of slack demand, bulging coporate cash coffers, and recovering personal savings rates, it's actually pretty stupid to have U.S. government spending and employment contract so quickly. I fear, however, that excessive concern about Solow's first, third, fourth and fifth points will swamp out the rest of his op-ed.
As for Haass, I'm not exactly sure what "rising rates" he's talking about, as just about any chart you can throw up shows historically low borrowing rates for the United States government. Indeed, the U.S. Treasury is exploiting this fact by locking in U.S. long-term debt at these rates. As for foreign governments pressuring the United States, the fear of foreign financial statecraft has been somewhat hyped by the foreign policy community. And by "somewhat hyped," I mean "wildly, massively overblown."
The bias in foreign policy circles and DC punditry is to bemoan staggering levels of U.S. debt. This bias does percolate down into the perceptions of ordinary Americans, which leads to wild misperceptions about the actual state of the U.S. economy and U.S. economic power. I'd like to see a lot more op-eds by Solow et al. that puncture these myths more effectively.
Am I missing anything?
As the markets begin their full-on freak out over the failure of Washington to raise the debt ceiling, I must confess to having a semi-out-of-body experience about the whole thing. The American in me is simply appalled by the stupid, self-destructive behavior that led to this thoroughly avoidable apocalypse. The political scientist in me, however, is utterly fascinated by the whole shebang. I understand that wartime photographers have the same kind of problem -- I wish they had a word for it.
So, taking my American hat off and putting my poli sci hat on, I find it fascinating that House Speaker John Boehner is having so much difficulty whipping a debt ceiling bill that is already a dead letter in the Senate. Conventionally, whipping is done through a mixture of cajoling, coercing and cash -- with an emphasis on the latter. A pet project here, a pet project there, and presto, you have a majority.
The problem is that the nature of the GOP House caucus, combined with the party's anti-government ideology, has stripped Boehner of everything but the cajoling. First, here's the Politico story on last night's whip effort:
Boehner and his top lieutenants worked deep into Thursday night trying to find a just-right solution that would attract 216 votes for the package of $900 billion in new borrowing authority, $917 billion in spending cuts over the next decade, and a process for entitlement and tax reform legislation that could lead to $1.6 trillion or so in deficit reduction and a second increase in the debt limit.
They don’t have available to them the same tools as past Republican leadership teams: There are no earmarks to hand out, nor any to take away, for example.
Rep. Jeff Flake (R-Ariz.), one of the last holdouts and a candidate for the Senate in Arizona, spoke of how “refreshing” it was to see a lobbying effort bereft of the legislative grease that used to secure last-minute votes in the House. He said the vote-building would have “cost $20 billion” in the past.
Yes, it's totally refreshing. It's also totally f**king useless, because Boehner isn't trying to cajole moderates, he's trying to cajole ideological hardliners. David Weigel explains in his wrap-up:
The Republican dilemma quickly revealed itself. In other situations where a majority party needed to grind out a few final votes, it called on members who agreed with the concept of legislation but quibbled with the text....
John Boehner and Eric Cantor couldn't sell their Republicans in the same way. Their diehards never wanted to raise the debt limit. They had supported a strict, doomed version of a debt ceiling deal, Cut, Cap, and Balance, which did that, but even then, they weren't really comfortable with the concept of what they were doing. They did not want to raise the debt limit. Their constituents were uncomfortable with the idea, at first. And now they were being asked to raise the limit, without the conditions they liked, because... why? Because they were told that failing to do so would give Barack Obama all the leverage in the debt fight. That was too clever by half for some Republicans. More than 24 Republicans, it seemed.
Tonight, reporters stalked outside the offices of Boehner and Cantor as members walked in and out for meetings. This wasn't like health care, or even the continuing resolution. We were watching diehard conservatives, who had never wanted to raise the debt limit, and who had never done so in their careers, being begged for votes. As the night dragged on, the visitors did not look like the sort who could cave on big, existential votes. Louie Gohmert, one of the diehards who believes that Tim Geithner is lying about the threat of default, was dragged in. Tim Scott, the co-president of the freshman class, was dragged in; he walked out nonplussed, walked past reporters, and took out his iPod earbuds to confirm he was a "no." Roscoe Bartlett, an octogeniaran, who's not usually counted on for tough votes, entered the hot room telling reporters he didn't want to choose between "bad and really bad." The farce peaked when Gohmert joined freshman Rep. Jeff Duncan, R-S.C., for a prayer session in the House's chapel. It can't be good when members of Congress are literally asking for salvation.
If you are looking only to God for a clue about how you should vote, neither material incentives nor political rhetoric is gonna sway you. And now you know why I think there's a 50/50 chance that no deal occurs by August 2.
UPDATE: Megan McArdle has some similar reactions to the same Politico story as I did.
Win McNamee/Getty Images
After last night's stunningly useless set of speeches, I'd put the odds of the U.S. not raising the debt ceiling by August 2nd at 1 in 2. Like many other observers, I'm finding it increasingly difficult to envision a deal that would get through the Senate while attracting a majority of House Republicans [You meant a majority of the House of Representatives, right?--ed. No, I meant a majority of House Republicans. I'm pretty sure that Boehner and the rest of the House GOP leadership will refuse to pass any debt ceiling plan that relies too much on House Democrats.]
So, it's gonna be a fun few weeks for those of us who study the global political economy. Let's start by thinking the unthinkable -- what will happen if there is a default?
I've expressed my feelings on the matter already, and I'm hardly the only one. That said, I've also
hedged my bets been flummoxed by the lack of market reaction to the DC stalemate. The lack of market reaction to date has emboldened House GOP members to stand fast. Could they be right?
Tom Oatley, who pooh-poohed my fears of the debtpocalypse last week, makes an interesting point about the composition of U.S. debt-holders:
By these figures, about 63% of US government debt is owned by central banks (foreign and domestic) and/sovereign wealth funds. Most of these entities are American friends and allies. Another 4% is owned by US state and local governments. That leaves 33%--about $4.8 trillion--in private hands. Of this, the financial institutions with the most restrictive regulations regarding asset ownership (depository institutions) own only 2% of the total ($290 billion). Mutual Funds, who may or may not have to dump downgraded debt, hold another 9% ($1.35 trillion).
What's the point? The discussion about the impact of US default revolves around the market response to default. Useful to recognize that most of the US government debt is held by public-sector agents who are much less sensitive to balance sheet pressures and regulatory constraints. These public sector agents are also substantially more sensitive to "moral suasion" and direct appeal than private financial institutions. The structure of ownership of US debt might dampen the negative impact of any default that does occur.
This is pretty interesting. Oatley focuses on "moral suasion," but there's also a national-interest motive for many U.S. debtholders. Most of the official holders of U.S. debt have a strong incentive for a) the value of their holdings not to plummet; and b) the United States economy to continue to snap up other their exports. If China, for example, is buying up U.S. debt to sustain its own growth, then neither a technical default nor a ratings downgrade should deter China or other export engines from continuing to buy U.S. debt even if there's a spot of trouble.
So it appears that complex interdependence will force America's rivals to continue to hold U.S. debt even after the debtpocalypse!! The United States in the clear, right?
Not so fast. Here are five "known unknowns" I can think of that might complicate Oatley's analysis:
1) What if the creditors form a cartel? In my 2009 paper, this was the one scenario that gave me the heebie-jeebies, because it's the one scenario under which creditors can wring geopolitical gains from debtor states. Any kind of default can act as a focal point moment in which U.S. creditors decide it's time to apply a haircut to American power and influence.
I don't think this is going to happen, because the national interests of American debtholders remain divergent. That said, if U.S. allies interpret default as a signal of U.S. unreliability in times of crisis, then all bets are off.
2) What about the economic nationalism of China? China is the largest foreign debtholder, which gives it a certain agenda-setting power in moments of crisis. There are a lot of compelling reasons why China would decide to try to minimize the economic disruptions . On the other hand, there's a lot of resentment on Chinese Internet boards already about the Chinese purchases of U.S. debt. During a period in which the CCP is already concerned about domestic instability, one could envision a scenario whereby they try to mollify nationalists at home by acting out against the United States.
3) What would be the effect of a mild market reaction on the House of Representatives? The less the markets react, the less that the House GOP will feel a need to do anything. There will come a point, therefore, when official debtholders might need to signal to the House that, in IPE lingo, "s**t needs to get done." That signal would in and of itself roil markets, not to mention the effects the current uncertainty is already having on the real economy.
4) What is the fiscal shock from a default? There are two causal mechanisms through which a default could affect the global economy. The first is through panic and uncertainty roiling financial markets. The second, however, is from a dramatic fiscal contraction due to limited government spending. Given the lackluster state of the current recovery, it wouldn't take much to tip the United States back into recession.
5) What if there's another AAA bubble? FT Alphaville's Tracy Alloway provided another interesting chart earlier this month on the distribution of AAA securities:
As Alloway warns:
[W]atch what starts happening from 2008 and 2009.
The AAA bubble re-inflates and suddenly sovereign debt becomes the major force driving the world’s triple-A supply. The turmoil of 2008 shunted some investors from ABS into safer sovereign debt, it’s true. But you also had a plethora of incoming bank regulation to purposefully herd investors towards holding more government bonds, plus a glut of central bank liquidity facilities accepting government IOUs as collateral. Where ABS dissipated, sovereign debt stood in to fill the gap. And more.
It’s one reason why the sovereign crisis is well and truly painful.
It’s a global repricing of risk, again, but one that has the potential for a much largerpop, so to speak.
We know that a downgrade of U.S. Treasuries would likely lead to a downgrade of state and municipal bond ratings as well. We also know that the ripple effects from the collapse of asset-backed securities were much larger than anticipated before the 2008 crisis. This is why the possible knock-on effects of downgrade so many AAA asserts makes me itchy. Even if banks and other financial institutions have minimal exposure to U.S. Treasuries, I don't think it's possible for them to have minimal exposure to all U.S.-based AAA sovereign debt.
These are just the five known unknowns that I could think of in the past hour -- there are probably many, many more. Readers are strongly encouraged to add them in the comments.
For those readers not keeping close tabs on the debt ceiling negotiations currently under way in Washington, here's how each participant views them:
There's been a lot of online debate about this question. Business Insider's Joe Weisenthal thinks this is just a matter of re-election motives, but I don't think it's that simple. As Nate Silver points out, "there is a larger ideological gap between House Republicans and Republican voters than there is between Republican voters and Democratic ones." Furthermore, many of the House GOP freshmen were elected in swing districts, so it's not as if they're representing only ultraconservative portions of the country.
I'd attribute the strategy of the House GOP caucus to two factors. The first is rhetorical blowback. It's simply impossible for elected representatives to say "we're not going to raise the debt ceiling, we're not going to raise the debt ceiling, we're not going to raise the debt ceiling..." and then actually raise the debt ceiling. And they really can't agree to the Mitch McConnell plan of "raise the debt ceiling with no concessions and then blame Obama." They can't agree to any "grand bargain" on austerity because any such bargain would have to include tax increases and there's that darn pledge not to. Politicians do occasionally go back on flat-out pledges not to do something. The example of George H. W. Bush to current GOP House members is not a good one, however. With blowback, it doesn't matter whether a member of Congress really and truly believes what they're saying or whether they can't reverse course without exposing their political backside. They're just as screwed.
The second factor is even simpler: to date the current Tea Party strategy of "no retreat, no surrender" has worked like political gangbusters. Recall that the conventional wisdom in Washington in early 2009 was that the GOP was going to have to be in the wilderness for a couple of election cycles before moderating their positions and winning at the polls again. The exact opposite of that scenario has occurred (see Erick Erickson on precisely this point). The Tea Party movement has been built on uncompromising hardline positions, and has led to significant electoral and political victories. As Joshua Green explains, even the exception proves this rule for Tea Partiers:
Unless and until the Tea Party wing of the GOP pays a political price for its positions, they have zero incentive to change their strategy.
Am I missing anything?
Hey, remember the rest of the world?
The Financial Times' Ben Hall and James Blitz report on a surprising degree of defense cooperation between London and Paris:
David Cameron, British prime minister, and Nicolas Sarkozy, French president, hailed their summit in London on Tuesday as an unprecedented move towards closer integration between Europe's pre-eminent military powers brought on by budgetary austerity but also a closer alignment of the two countries' foreign policies.
They signed two treaties: one covering the sharing of technology used to maintain nuclear warheads and another on initiatives about conventional forces.
Mr. Sarkozy said the agreement to share a new research facility in France for the testing of nuclear warheads was testament to a "level of confidence between our two nations unequalled in history".
Until now, France and Britain have closely guarded the secrets of their nuclear deterrents, regarding them as the bedrock of their independence.
Mr Cameron said the two treaties would commit the French and British armed forces to working "more closely than ever before".
Paris and London also agreed to set up an "integrated carrier strike group", allowing each to fly combat aircraft from the other’s carrier once Britain has an operational ship equipped with its U.S.-built Joint Strike Fighter jets, by the beginning of the next decade. In the next 10 years, the French and British navies would centre co-operation on the Charles de Gaulle, France’s only carrier.
What's interesting about this is not the military effects -- in the end, this is about trying to do more with less -- but the political ones. In a world of austerity, there is some logic in close allies working together to eliminate redundant platforms and/or other fixed costs that could be pooled across countries. Furthermore, this kind of defense integration, once started, would strike me as very hard to reverse.
This year has seen a lot of people predicting the end of the EU and NATO as Europe struggles with its economic misfortune. I wonder, however, if hard times are actually having the opposite effect of forcing European and NATO countries closer together. This might not be popular, but it's the only viable policy option in some instances.
Daniel W. Drezner is professor of international politics at the Fletcher School of Law and Diplomacy at Tufts University.