Wednesday, August 21, 2013

Debt Ceiling Showdown?

I am beginning to rethink my earlier forecast that the GOP leadership will be able to steer their base away from a debt ceiling showdown. Here's my rationale:

The Conservative dream strategy is to get a Budget resolution that specifically defunds Obamacare through both Houses, and send it to the president before the end of September, forcing him to veto it, so he can be blamed for a shutdown. Problem is - this won't happen. Such a Budget resolution won't get through the Senate. So September 30 will approach, with no unified position, and I predict a last minute CR, continuing funding at current levels, including Obamacare, lasting until, say, December 1, after the debt ceiling end date, which will be some time in November, but possibly sooner.

House Conservatives will be convinced to support the CR by their leaders telling them, "Let's get the CR through, and put all our ammunition into the Debt Ceiling fight." And the Budget Battle of October 2013 will be underway. And here's the Big Problem: Obama will not negotiate over the debt ceiling. He has said this repeatedly And consistently GOP leadership has said that the President has to wake up and get real, that he does not have any choice. They think he will hold out until late in the game, then cave. They're wrong.

With just a few days to go until potential default, what will the GOP do? More generally, what will they do at the point they realize the President will hold firm - will they quickly move a clean debt ceiling increase through both Houses, or will they go straight for the abyss, or will they try a clean resolution and cut it too close?

If they get a clean resolution signed in time - an enormous defeat for the GOP, the fight will move to the end date for the CR. Will they still be loaded for bear, itching for a fight, or will they get a sudden case of moderation politics. At this point, it seems like that could go either way, but right now, I want to focus on what happens if a debt ceiling increase resolution is not completed in time.

What will Obama do? And I want to stress that though the odds of this scenario showing up are not yet, in my mind, over 30%, they are a long way from zero. What would the President do?

I predict he would claim authority under the 14th Amendment to protect US Government debt, and he would order the Fed to continue to supply funds to the Treasury General Account, so that the Government could carry on its business, and meet its proper obligations, including all required debt service payments.

An alternative, discussed at length inside MMT circles and well beyond, during the Summer 2011 debt ceiling crisis, was to have Treasury exercise its powers of seigniorage, and mint a $1 Trillion coin, deposit it into the TGA account, and require the Fed to fund it by adding $1 Trillion in money into the TGA. TGA balance goes up, without adding new debt. Lots of experts say this is perfectly legal. Obama rejected it before, and will, I believe, reject it again. He does not want a magic trick. He does not want to be Bagger Vance, the magical negro, to the American golf game.

But this time, if forced, he will exercise his authority under the 14th Amendment and avoid default. Suspect the GOP will immediately try to begin impeachment hearings. It's possible the GOP leadership will realize this is a bad idea - that a President exercising the authority that is arguably his under the Constitution, in a successful effort to prevent a US default, is very different from the philandering, untruthful Clinton, and the GOP ultimately lost there anyway. So if we get there, we shall have a chance to see which way the GOP goes. A failed impeachment effort would be a huge disaster. Forcing the President to act to prevent default is probably only a disaster. Both would support my prediction for a turnover of the House in November 2014.

That's the politics of it. Now a word about the economics. Do you, the reader, understand what would happen, if the President gave the order to the Fed to keep putting money in the Treasury Account, so Treasury could pay the country's bills? No extra taxes come in. No new debt is issued. But the Fed just keeps refilling the Treasury's bank account. With what? With new money, created by a few simple computer keystrokes. Where does this money come from? It's created out of thin air. How much could the Fed create? An infinite amount. How could it be worth anything, if it comes from nothing, is created ex nihilo? That's the amazing mystery of fiat money - it's worth what people and markets say it's worth, and that turns out to be reasonably consistent over time, and it's greatly helped by the fact that this is the unit of exchange that the Government will accept to pay tax obligations.

If this scenario plays out, this will be an amazing teaching moment, where I expect leaders of MMT will be on camera and in the press a lot, explaining what money really is, and how the Government has all it will ever need, and that rules that normally prevent the Fed from creating money this way are simply legislative requirements; they have nothing to do with the underlying economics. The US, as a sovereign currency issuer, has always as much money as it needs. All limitations are self-imposed. There is not now and never will be a budget problem. We could even create enough money to pay off the national debt tomorrow. In a smallish way, that's what the Fed has been doing with QE: creating new, computer keystroke reserves and using these to buy back debt securities from banks. If we did this long enough, the Fed would own all the national debt; Treasury would pay the Fed interest, and the Fed would return that interest to the Treasury.

Effectively, the debt would be eliminated. But what about the $16 trillion now on the Fed balance sheet? Doesn't that have to be put back out into the market, and wouldn't doing so, destroy the market and hike yields to hyper-inflationary levels? No. This debt does not have to be put back into the market. It can be held to maturity, and over time the bonds would simply disappear.

What about all that money pumped into the economy as the Fed bought back the $16 trillion of debt. Like the $1.5 trillion in excess reserves the banks are holding now, money generated from QE I, II, and III, with no inflationary affects, $16 trillion could sit on bank balance sheets without inflationary impact, because reserves - the base money the Fed controls and creates, never enters the real economy, because, contrary to macroeconomics textbooks, the banks do not lend reserves; they make loans to creditworthy customers, and, if necessary, go borrow the requisite reserves from the interbank market, or from the Fed. Excess reserves on bank balance sheets will not directly increase Broad Money (M1, M2, M3).

Most folks, including a lot of very smart ones like Paul Krugman, simply do not understand the above. It is, I believe, the mission of MMT to educate opinion leaders and the public over time, that this is really how the money creation process works, and that most of the restraints we talk about are self-imposed.

We need to begin imagining what the world would be like if the policy makers and political leaders actually knew that we are not constrained by an absence of financial resources; we are only constrained by the capacity limitations of our economic resources, by how productive we can be with our current supply of human and capital resources. Wouldn't that just be amazing?

And remember, there are very few mainline economists and no political leaders who really understand this. But it's true. Have spent the last three years studying this, and I know this is the truth.

MMT surely has their work cut out for them.

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