Slow Trains Coming Together on the Same Track

It's disappointing, but it became clear this week that the $4 billion deficit reduction deal is not going to happen. It seemed close at one point about a week ago, with Speaker Boehner and President Obama negotiating directly on a package of that size--the size that a number of parties have indicated all along was needed for credible deficit reform--that included some reductions in entitlement costs and tax revenue increases, both of which were clearly necessary for an agreement of that size.

What happened since then is that Speaker Boehner was rebuffed by his party's caucus in the House. The problem is the Grover Norquist Pledge to vote against any net increase in Federal taxes--most House Republicans, and sufficient Senate Republicans, have signed it--and most who've signed it are unwilling to go back on it. Republican House Minority Leader Eric Cantor became the mouthpiece of those House Republicans, and they effectively undercut Boehner's ability to negotiate a deal of this magnitude.

So, there will be no tax increases, and there will be no corresponding ground offered on Medicare cuts (My proposal, to make Medicare benefits taxable, would make the two items--increase in revenue, and effective reduction in Medicare costs--equal, without making an explicit tradeoff, but I haven't heard it proposed yet, just "means tests" to make Medicare benefits more expensive for the wealthy.) This seems to limit the cuts that can be agreed upon to something like $1.5 billion over the next 10 years.

Boehner laid down a principle that the budget cuts should exceed the approved amount in the debt ceiling, which would need to be some $2.5 billion to get the government safely past the 2012 elections (or so I'm told). This is where the nefarious scheming of Senate Minority Leader Mitch McConnell comes in. He's proposed some kind of complicated approach would give Obama the power to increase the debt limit for some amount of time unless two-thirds majorities of both houses voted to block it; it has the benefit of removing debt limit increases as a stumbling block for the economy, and it would allow most Republicans to vote against Obama's Debt Limit Increases.

So, the outlines of the final deal become clear--at least to me. $1.5 billion in cuts over ten years, some small increases in taxes through loophole closing, offset entirely by extensions of the payroll tax cut (so, no net increase in taxes and no violation of the Norquist Pledge), which would ensure sufficient Democratic votes for passage, and the McConnell clause which would come up in a year or so, during the election campaign, to allow Obama to get the debt limit past the election, but in a sufficiently politically damaging fashion to please Republican Congresspeople.

Tea Party Economics
Michele Bachmann has emerged as the anti-Romney candidate for at least the first portion of the 2012 Republican nomination race--I still think she will fade, and that Rick Perry will take up the torch--but that will happen sometime around when she loses in New Hampshire, gets creamed in Nevada, and doesn't do quite well enough in South Carolina. Meanwhile, her strong standing in polls, particularly in Iowa, make her someone everyone has to notice.

What she's saying about the debt ceiling is that Tim Geithner and Company are not telling us the truth if they say we will default on our debts on August 3rd if the debt ceiling is not raised. In this, I think she is factually correct, but completely wrong in the conclusion she draws from this, namely that it is OK to deny President Obama an increase in the debt ceiling, something she's basically promised to vote to do.

The statements of Geithner and Obama on this have been careful and are relatively clear. The Federal government is limited by statute to $14.8 billion (or whatever the exact number) in debt. When we reach that debt, they will pay some bills from cash on hand, they will raise money by selling assets to pay other debts, and they could challenge the constitutionality of the statute (on the 14th Amendment grounds), though they don't mention that one. They could prolong any default on any debts for some number of months--not a lot, but long enough to create a major crisis and probably break the resolve of Republicans to prevent a debt limit increase--if they had a resolve to do that.

I think it is clear that they do not have such a united resolved. The Republican leaders in both the House and Senate have shown that they recognize the danger: it's not so much an economic danger (more of that in a moment), but a political one that they don't want to face. They don't want to re-do 1995, which had a shutdown crisis which caused the Republicans to lose their hard-won House majority and go into the 1996 Presidential election already defeated. Something like half of the Republican members of the House have a hardcore Tea Party view like Bachmann's and will vote against any debt limit increase, but that will be offset if there is a compromise that is acceptable to a comparable number of Democratic House members.

The economic consequences of an actual government default are huge, but that is not going to happen, for the political and administrative reasons I've outlined. An economic catastrophe could still happen, though, and it would look something like this: we get to the last week in July and there is still no deal. Wall Street and the global capital markets finally decide the crisis is real and interest rates shoot up dramatically, led by Treasuries, but including all forms of debts. A small, late deal is produced by August 2, or shortly thereafter, so there is no default, but the meager nature of the deal inspires no confidence--rates come down very little or not at all, the country is plunged back into recession (with the rest of the globe following), and the political consequences--well, they would be severe, most likely punishing both parties somehow, with some kind of third-party desperation move (or multiple ones) emerging (Bloomberg? Donald Trump? Something even worse?)

I would conclude that it is in the interest of both parties to come up with that middle-small, face-saving deal that I outlined, and that they should do it in the next 10 days.