Monday, July 11, 2011

The Bogeyman the Republicans Refuse to See

Most normal people are scared of the bogeyman their imaginations conjure up, but tell themselves it isn't real and use various techniques calm themselves down and make it go away.

Republicans refuse to believe that a very real disaster could possibly happen when the debt ceiling is hit. By refusing to see this very real "reality", they are ensuring that the US will truly stumble into this financial disaster. And when this does happen these Republicans will truly be scared silly by the very bogeyman created by their witless refusal to face facts. But by this time, it will be too late for everyone because by then the US economy will have tanked and a "night of the living dead" horror story will be unleashed on the whole nation.

Here's a post by Jeff Frankel, a Harvard professor of Capital Formation and Growth, and who directs the Program in International Finance and Macroeconomics at the National Bureau of Economic Research, where he is also on the Business Cycle Dating Committee, which officially declared the 2001 recession that explains just precisely how this horror story works:
In the 1955 movie Rebel Without a Cause, James Dean and a teenage rival race two cars to the edge of a cliff in a game of chicken. Both intend to jump out at the last moment. But the other guy miscalculates, and goes over the cliff with the car.

This is the game that is being played out in Washington this month over the debt ceiling. The chance is at least 1/4 that the result will be similarly disastrous.

It is amazing that the financial markets continue to view the standoff with equanimity. Interest rates on US treasury bonds remain very low, barely above 3% at the ten-year maturity. Evidently it is still considered a sign of sophistication to say “This is just politics as usual. They will come to an agreement in the end.” Probably they will. But maybe not. (I’d put a ½ probability on an agreement that raises the debt limit, but just muddles through in terms of the genuine long term fiscal problem. That leaves at most a ¼ probability of a genuine long-term solution of the sort that President Obama apparently proposed last week - described as worth $4 trillion over ten years.)

My advice to investors is to shift immediately out of US treasuries and into high-rated corporate bonds. If the worst happens, you will probably save yourself from a big capital loss within the next month. If not, there is no harm done.

The game is not symmetric. The Republicans are the ones who are miscalculating. Evidently they are confident of prevailing: they rejected the President’s offer, even though he was willing to cut entitlement programs.

The situation is complicated because there are a number of different people crammed into the Republican car. There is one guy who is obsessed with the theory that, come August 3, the federal government could retain its top credit rating if it continued to service its debt by ceasing payment on its other bills. But this would mean failing to honor legal obligations that have already been incurred (paying suppliers for paper clips that have already been bought, paying soldiers their wages for last month’s service, sending social security recipients their checks, etc.). This is like observing that the cliff is not a 90 degree drop-off, but only 110 degrees. It doesn’t matter: the car would still go crashing into the ocean far below. The government’s credit would still be downgraded and global investors would still demand higher interest rates to hold US treasuries, probably on a long-term basis.

There are other guys (and gals) in the car who are even more delusional. They are dead set on a policy of immediately eliminating the budget deficit (e.g., those opposed to raising the debt ceiling no matter what, or those campaigning for a balanced budget amendment), and doing it primarily by cutting nondefense discretionary spending. This is literally impossible, arithmetically. But they honestly don’t know this. It is as if they were insisting that the car can fly. Sometimes it can be a good bargaining position to adopt a very extreme position. But if you are demanding that the car flies, you are not going to get your way no matter how determined you are.

It seems likely that the man in the driver’s seat - House Speaker John Boehner - does realize that his fellow passengers don’t have the facts quite right. But there is also a game of chicken going on within the Republican car. The crazies have said they will oppose in the next Republican primary election any congressman who votes to raise the debt ceiling or to raise tax revenues. (Yes, they think they would support someone who would eliminate the budget deficit primarily by cutting non-defense discretionary spending; but remember, this is arithmetically impossible.) The guy who is riding shot-gun in the car - the one who believes the car can fly — is trying to put his foot on top of Boehner’s on the accelerator pedal.

It seems to me that Boehner, too, is miscalculating. Given that the car can’t fly, the crazy guy is probably going to oppose him in the primaries no matter what he does. So I don’t see what his plan is. But whatever it is, he has made it clear that he doesn’t plan to agree to any increase in tax revenues.

As a result the Republican leadership is in the remarkable situation of refusing to agree to Obama’s offer to solve the problem so long as the solution includes raising tax revenue, even if it is via such measures as ending distortionary subsidies for ethanol, oil companies, and corporate jets.

If I had to guess: The financial markets will wake up just before August 3. US bond prices will finally fall. The market reaction will shock the Republican leadership into action. (Precedents include the delayed congressional passage of the unpopular TARP legislation in the fall of 2008 and the delayed passage of an unpopular IMF quota increase 10 years earlier.) They will finally make the small but necessary concessions on tax revenues. But by then it might be too late.
Of course the Republicans don't believe a word of this. They are "experts" and Frankel is just a "pointy-headed intellectual" as ex-Vice President Spiro Agnew (who went to jail for his crimes) loved to tell the American people. Why believe somebody who worked hard to earn a degree and teaches at one of the premier universities in the world when you can listen to an ignorant ex-con who finagled his way to high political office using extortion, tax fraud, bribery and conspiracy?

Why believe a Harvard professor when you can believe a previous low-level IRS employee like Michele Bachmann who uses her previous debt-collecting skills at the IRS to plumb the depth of this issue and come up with the conclusion:
After Obama's speech, Rep. Michele Bachmann (R., Minn.), a presidential contender who is currently at the top of the polls in Iowa, issued a statement reiterating that she wouldn't vote to raise the debt ceiling. She said Obama "has wrongly assumed that everyone agrees that we need to raise the debt ceiling... I disagree."

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