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October 3, 2013 at 10:32 AM
Default is no longer just a theory
The minority of House Republicans in safe red districts that are holding the government hostage unless it defunds Obamacare — an issue supposedly settled in the last election — do not even believe in the Theory of Evolution. Why should they believe their actions could lead to a catastrophic default on U.S. debt? But this eventuality, which would happen soon after the government hits the statutory debt limit, is no longer just a scary story economists tell each other over campfires. It is barreling toward us. Today’s fall in stock prices is only one of the warnings.
Christine Lagarde, managing director of the International Monetary Fund, said in a speech today, “The government shutdown is bad enough, but failure to raise the debt ceiling would be far worse, and could very seriously damage not only the U.S. economy, but the entire global economy.” The Treasury Department issued a report, The Potential Macroeconomic Effect of Debt Ceiling Brinksmanship. It states, “a default would be unprecedented and has the potential to be catastrophic: credit markets could freeze, the value of the dollar could plummet, and U.S. interest rates could skyrocket, potentially resulting in a financial crisis and recession that could echo the events of 2008 or worse.”
House Speaker John Boehner reportedly told Republicans today he won’t allow a default to happen. But Boehner does not control his own caucus, and still seems unwilling to allow a vote in the House where both Democrats and some Republicans could pass a clean budget resolution and raise the debt ceiling (the debt ceiling has been raised 42 times since 1980). Wall Street and big business are learning that they, too, do not have much power over the nihilist, tea party Republicans. Whatever is going on here, it is not conservatism.
At stake is the full faith and credit of the world’s largest economy, a promise that underpins the world financial system. As I wrote earlier this week, it is bad enough that the economy now is much weaker than during the 1995 shutdown. But failing to raise the debt ceiling would immediately undermine Treasury notes as the world’s safest investment. It would ripple into Treasury holdings overseas, including by central banks. We’ve been on quite a borrowing binge with tax cuts, two wars and Medicare D, all on the credit card. Also at risk, the dollar as the world’s reserve currency, which allows that credit card to be almost limitless.
Long term, it will encourage the world to reset its investments in other safe havens and other currencies — not just euros but China’s renminbi. But that happens on the other side of a calamity that would make the collapse of Lehman Brothers look like a spill in the park. I’ve always been fond of Abba Eban’s quote, “When all else fails, men turn to reason.” But parsing the words in the context of this unprecedented constitutional crisis and breakdown of democratic governance, does this mean all else must fail? If so, God help us.
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Today’s Econ Haiku:
Open our wallets
Boeing, take all that you want
Will even that fly?