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Monday, July 11, 2011

Jeff Frankel: The Federal Government Approaches the Cliff

Jeff Frankel:

Advice to Investors, as the Federal Government Approaches the Cliff, by Jeff Frankel: In the 1955 movie Rebel Without a Cause, James Dean and a teenage rival drive 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 greater than 1/4 that the result will be similarly disastrous. ...

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 idea 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., not raising the debt ceiling no matter what, or passing 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 the other guys 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. ...  They will finally make the small but necessary concessions on tax revenues. But by then it might be too late.

The idea of "a number of different people crammed into the Republican car" reminds me of clowns at the circus, and for good reason.

    Posted by on Monday, July 11, 2011 at 04:32 PM in Budget Deficit, Economics, Politics | Permalink  Comments (38)


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