You Get What You Pay For

Simon Johnson, the former chief economist at the International Monetary Fund, is the co-author of “13 Bankers.”

Standard & Poor’s downgrade of United States government debt last month has been much debated, but not enough attention has been devoted to the fact, reported last week by Bloomberg News, that it continues to rate securities based on subprime mortgages as AAA.

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In short, S.&P. is suggesting that these mortgages are more creditworthy than the United States government — a striking proposition. Leave aside for a moment that S.&P. made a big mistake in its analysis of the federal budget (as explained by James Kwak in our blog). Just focus on all the things that can go wrong with subprime mortgages: housing prices can fall, people can lose jobs, the economy may fall into recession and so on.

Perspectives from expert contributors.

Now weigh those risks against the possibility that the United States government will default. As we learned this summer, that is not a zero-probability event — but it would take either an act of Congress, in the sense of passing legislation, or a determination by members of Congress that they could not act. S.&P. finds this more likely to happen than some subprime mortgages’ going bad.

Now S.&P. might be right, of course. Or its assessment might be influenced by the fact that it is paid by the issuer of those mortgage-backed securities — which presumably wants a higher rating. The rating agency’s employees may want to do an accurate assessment; management can reasonably expect to make higher profits if its ratings please the paying customers.

Perhaps we should just disregard what S.&P. and its competitors say. But this is not so easy, because many investors are guided by rules — either self-imposed or created by regulators — that tie investment decisions, and thus these investors’ holdings, to ratings. Ratings changes undeniably can move markets.

How can we take seriously a rating agency that is compensated by the issuers of securities? This system has long outlived its usefulness and should be discontinued.

In a similar vein, let me ask why we should take seriously economic analysis offered up by a financial-sector lobbying group on behalf of its members — if, for example, it says that regulation of its members will slow economic growth? Surely, we should check the numbers in the analysis carefully and be skeptical of the policy recommendations.

A timely example comes from the Institute of International Finance, which calls itself “the Global Association of Financial Institutions” and whose board members are all from big banks. (Indeed, the institute is more than a mere lobbying group; in the recent Greek debt negotiations, it was in charge of coordinating the terms proposed by private-sector banks for their involvement in the debt restructuring.)

So what do we make of its policy recommendations? In a report released this week, “The Cumulative Impact on the Global Economy of Changes in the Financial Regulatory Framework,” for example, the institute asserts that additional capital requirements for its members could result in “3.2 percent lower output by 2015 in these economies than would otherwise be the case” (see Paragraph 5 of its news release accompanying the report).

In recent conversations with some policy makers from the Group of 7 nations, I was told that the institute’s previous, interim report on this same topic was largely without value (some said completely without value).

I hope these policy makers and others react the same way in this instance, because the institute refuses to acknowledge the vast cost imposed on society by the combination of big banks, high leverage and low capital that it endorsed through 2008 and that it defends today, with only minor modifications. (James Kwak and I wrote directly about these issues in “13 Bankers” — and we’re now hard at work on the sequel.)

The institute’s report is nothing more than lobbying masquerading as economic analysis. And just as S.&P. is paid for its ratings by the issuers, the institute is paid to represent the views of big banks. We would be wise to suspect that in both cases, the paying customer would prefer a particular outcome — irrespective of what the evidence says.

Defining Economic Interest

Nancy Folbre is an economics professor at the University of Massachusetts Amherst.

Republican resistance to raising taxes represents a distinctly minority view. The latest New York Times/CBS poll shows that only 34 percent of adults believe that taxes should not be increased on households earning $250,000 or more to lower the budget deficit. Even this modest percentage surprises me, because only about 2 percent of American households report income above this amount.

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Most conservative economists argue that higher tax rates at the top would hurt everyone because they would lower economic growth. I don’t buy this argument for a variety of reasons that I’ve explained elsewhere. However, the argument seems pretty easy to sell.

Perspectives from expert contributors.

People don’t always recognize and effectively act on their economic interests. As one of my favorite behavioral economists, Dan Ariely, put it, we are all more like Homer Simpson than Superman.

I’ve always identified more with Marge Simpson than with Homer, but in any case, if the Simpsons don’t act on what we believe are their economic interests, economists should be able to explain why.

Reaching for a better understanding of the Tea Party seems like a good place to start, since it gets much of the credit or blame for current Republican priorities.

According to last week’s poll, Tea Party members are slightly better educated and more prosperous than the typical American. Still, only 17 percent earned more than $100,000 a year and 2 percent earned more than $250,000. I wish the survey had asked how many were unemployed or working in the public sector.

Some evidence suggests that the Tea Party’s interests are shaped by its racial composition. Surveys show that it includes few African-Americans (3 percent of the total) and has greater membership in the South than in other regions (41 percent of voters compared with 15 percent in the Northeast).

At that time, a majority reported that they believed that “too much has been made of the problems facing black people” (52 percent compared with 28 percent of all Americans).

Asked to volunteer what they don’t like about President Obama, the top answer, offered by 19 percent of Tea Party supporters, was that they just didn’t like him.

The most recent poll confirms this animus: Only 12 percent of Tea Party supporters approve of President Obama’s job performance, compared with 20 percent of Republicans and 48 percent of Americans.

Dislike and disapproval obviously inclined them to support Republicans who gave the president a hard time. But as Kate Zernike pointed out in a recent article in The New York Times, Tea Party members did not line up squarely behind those who wear their mantle in Congress. A CBS News poll taken in mid-July showed that 53 percent of Tea Party members, along with 66 percent of all respondents, favored a combination of tax increases and spending cuts.

One self-identified Tea Party Web site goes so far as to decry wealth inequality and calls for a progressive tax on wealth.

So why did Tea Party Republicans in Congress take such a hard line? Their views — like those of most other elected representatives — are not primarily shaped by the views of their constituents.

While the Tea Party movement got a big initial boost from small donors, its elected representatives quickly began relying on political action committees and major contributions from Wall Street firms. These almost certainly grew after the Supreme Court, in its Citizens United decision in January 2010, loosened campaign finance restrictions.

Many Tea Party members may be unaware of the extent to which wealthy political conservatives like the Koch brothers have bankrolled their efforts and shaped legislative priorities.

Partly because it does enjoy significant grass-roots support, the Tea Party has helped Republicans deflect attention from growing concerns about economic inequality and class conflict.

But these concerns are likely to intensify as unemployment rates remain high and the economy moves back toward official recession.

An ABC News/Washington Post poll conducted last month found that most Americans said the biggest difference between President Obama and Republicans lay in whose economic interests they aimed to serve.

Perceived differences based on household income categories, like the “$250,000” benchmark, seem less salient than those based on big business versus everybody else.

A striking 67 percent of Americans said Republicans were protecting the interests of large business corporations, compared with 24 percent who believe the same of President Obama (see chart below).

Meanwhile, the Tea Party is taking the fall. Its popularity has declined significantly in recent months. The latest New York Times/CBS News poll found the Tea Party was viewed unfavorably by 40 percent of the public, up from 29 percent in April.

As the economy nosedives, Tea Party populists are likely to become even less popular. And perhaps Tea Party members will change their perception of where their own economic interests lie.

For Stocks, Day 7 Since the Walkout

Tuesday was the seventh trading day since John Boehner walked out of talks with Barack Obama at the White House. That move made it clear that the House speaker would not risk alienating the Tea Party and that if a debt default were to be averted, the president would have to capitulate on virtually all issues or defy Congress by claiming the debt limit legislation was unconstitutional. He chose to capitulate.

FLOYD NORRIS

Notions on high and low finance.

This is also the seventh consecutive session that the Standard & Poor’s 500-stock index has declined. The total fall for the seven days is 6.8 percent.

Notions on high and low finance.

This is something that Wall Street did not see coming. It took for granted that something more reasonable would be worked out. To make it worse, the economic data has turned much bleaker, highlighted by last Friday’s revisions in the gross domestic product. In normal times, the politicians would be vying to come up with plans to stimulate the economy. Now that seems to be out of the question, and there is more talk of a double-dip recession than at any time since the last downturn ended.

The last time I can recall Wall Street’s being so wrong about what the government would do was in September 2008. Lehman Brothers was collapsing, but the Bear Stearns precedent provided assurance that the government would not take the risks to the financial system inherent in letting a big bank fail.

Over the seven sessions after the Lehman bankruptcy, the S.&P. fell 5.1 percent. It was a much wilder ride than this one, with two days when the market lost more than 4 percent and two days when it rose more than 4 percent. The market would go on to lose much more. By contrast, the largest decline in this string was Tuesday’s fall of 2.6 percent.

Wall Street was so very wrong in 2008 because ideology trumped caution in Washington. Sort of like what seems to be happening now.

Could This Deal Raise Budget Deficits?

“From an accounting point of view, it seems obvious that you would reduce G.D.P. if you cut government spending,” said Randall Kroszner, an economics professor at the University of Chicago and a former Fed governor appointed by Mr. Bush. “But the key is really the impact on consumption and investment. If you reduce government spending and if people think that reduces uncertainty about the tax burden down the line, they may be more comfortable with spending.”

FLOYD NORRIS

Notions on high and low finance.

It is virtually impossible to think of the impact of the debt deal as doing anything to help the economy. But give Mr. Kroszner credit for trying, in today’s front-page article by Binyamin Appelbaum and Catherine Rampell.

Notions on high and low finance.

To come up with a rosy scenario, he suggests that uncertainty may somehow be reduced, leading to more consumption and investment. I cannot imagine anyone actually thinking this deal — with its clear potential for another bruising fight and deadlock that will do more to hurt the economy — decreases uncertainty.

In fact, this deal could manage to do the exact opposite of what it promises — raise the deficit.

If that happens, it will be because a major determinant of tax revenue is the health of the economy. Profits and growth bring revenues. This could damage the economy enough to send tax receipts down again. Although you never would have guessed it from the rhetoric, tax receipts are at the lowest level in years, as a percentage of gross domestic product. Get a healthy economy and tax revenues rise while a lot of spending, on such things as unemployment benefits, goes away.

What this has shown is that the Republican Congressional leadership is terrified of the Tea Party and of people like Sarah Palin, who hinted she would support a primary challenge to any Republican who voted to raise the debt ceiling. The leadership knew that not raising the ceiling was unthinkable, but many of the members did not.

The next showdown — assuming Congress passes the deal on Monday — will come directly after the 2012 election, but with the current Congress. So even if these people are thrown out, they have assured themselves one last chance to be totally irresponsible. Then, when the new Congress tries to undo the damage, the ones who are still there can filibuster.

What has been proved by this is that there are a substantial number of members of Congress who basically are opposed to the government and welcome anything that would keep it from functioning. If the Republican leadership again grants them veto power over anything, some of them will think that forcing huge spending cuts at the end of 2012 will have been a triumph, no matter what it does to the economy or to Americans less well off than themselves.

If Mr. Kroszner’s rosy scenario seems unreal, there might still be one. It relies on the fact that fiscal and monetary stimulus work with lags. When recoveries really get going, they can become self-sustaining quickly.

The normal course after recessions before the 1990s was for complaints that nothing was happening to turn overnight to amazement about how fast recovery is taking hold, and then to be followed by complaints that the last round of stimulus was unnecessary.

Is it possible that we have reached an inflection point, and that despite the weak economic numbers there is really no need for more stimulus?

Yes, it is.

Is it likely?

Not so much.

What is clear is that the lessons of the 1930s — that you don’t deal with weakness by cutting back — have been forgotten or were never learned.

Doing Away With the Debt Ceiling

Bruce Bartlett held senior policy roles in the Reagan and George H.W. Bush administrations and served on the staffs of Representatives Jack Kemp and Ron Paul.

Almost 10 years ago, I testified before the Senate Finance Committee that the debt limit should be abolished. Among the others who testified that day, including Treasury Secretary Paul O’Neill, no one supported my position.

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What we have seen, currently and in the years since that hearing, is that for any politician to deny the validity of the debt limit is effectively to support unlimited debt, something no member of either party can afford to be accused of.

Perspectives from expert contributors.

The negotiations leading up to Sunday night’s announcement that President Obama and Congressional leaders of both parties had reached a deal to cut trillions of dollars in federal spending over the next decade makes the case against the debt limit that much stronger. We now know that it is a powerful mechanism for political extortion.

Unless the party holding the White House has a comfortable majority in the House of Representatives and at least 60 seats in the Senate, raising the debt limit is going to remain a means by which the minority party can impose its demands on the majority.

Even if the Treasury avoids default on government debt this week, we will inevitably have to go through the same political drama the next time the debt limit runs out and every time thereafter. And sooner or later the shoe will be on the other foot, as Democrats hold the debt limit hostage against a Republican president.

Unfortunately, the option of just letting the debt limit expire is not available. It is permanent law and can be abolished only by repeal or by a ruling by the Supreme Court that it is unconstitutional. Note that the law does not impose a deadline at which the debt limit runs out; rather, the limit is a dollar figure that must be amended when the gross federal debt reaches it. The date when the limit is breached is a function of Treasury’s cash flow and expenses.

The Constitution grants Congress the power to “borrow money on the credit of the United States.” Before World War I, it had to authorize each and every Treasury bond issue and its precise terms. During an era when the federal budget was usually balanced, this was not a huge problem.

But with the unprecedented borrowing needs of the First World War, Congress ceded to Treasury the power to decide when and under what terms it would borrow, subject only to an overall dollar limitation.

While politicians and the general public believe that the debt limit is an important constraint on national indebtedness, not one iota of evidence supports this belief. Economists have been making this point repeatedly for more than 50 years. In 1959, Marshall Robinson of the Brookings Institution came to this conclusion in a book-length study of the debt limit:

On the record, the debt ceiling experiment has failed. Although at times the ceiling has clamped down on government spending, it has not prevented the long-term growth of debt. Indeed, there is some evidence that reactions to its short-run pressure may ultimately contribute to the growth of debt.

Before 1974, it was plausible to argue that there was some virtue in having a debt limit because it forced Congress to acknowledge the consequences of deficit spending from time to time. But that year, it enacted the Congressional Budget and Impoundment Control Act, which requires Congress to enact a budget resolution annually that specifies an appropriate level for the deficit and the debt.

Consequently, a separate vote on the debt limit is at best superfluous. As the General Accounting Office put it in a 1979 report:

The implementation of the Congressional Budget and Impoundment Control Act of 1974 has brought into question the need for the Congress to consider the debt ceiling separately from the budget process.

This fact led Alan Greenspan, then chairman of the Federal Reserve, to recommend abolition of the debt limit in 2003 testimony:

In the Congress’s review of the mechanisms governing the budget process, you may want to reconsider whether the statutory limit on the public debt is a useful device. As a matter of arithmetic, the debt ceiling is either redundant or inconsistent with the paths of revenues and outlays you specify when you legislate a budget.

Mr. Greenspan’s point is crucial: the decision to run a deficit and increase national indebtedness is made by Congress when it votes to cut taxes, create entitlement programs and enact appropriations that will necessarily cause spending to be higher than revenues – not when it raises the debt limit.

As the Congressional Budget Office put it in a 2010 report:

By itself, setting a limit on the debt is an ineffective means of controlling deficits because the decisions that necessitate borrowing are made through other legislative actions. By the time an increase in the debt ceiling comes up for approval, it is too late to avoid paying the government’s pending bills without incurring serious negative consequences.

It is nothing but grandstanding for members of both parties to vote routinely for legislation that they know will create deficits and then profess shock and horror that the debt limit must be increased as a consequence. Even Captain Renault in “Casablanca” would be offended by such hypocrisy.

Historically, raising the debt limit was mere political theater giving cover to Congressional double-talkers because everyone knew that it would be increased. But that is no longer a foregone conclusion now that a significant number of Republicans in both the House and Senate believe that default on the debt is preferable to deficit spending.

Indeed, many say publicly that they will never support a debt limit increase under any circumstances and will even filibuster one, asserting that default would actually be a good thing because the budget would be balanced overnight.

For these reasons, the debt limit must be abolished. While that is extremely unlikely at this time, it is nevertheless necessary. As the computer eventually learned in the movie “War Games,” the only way to avoid disaster in this sort of game is not to play.

The Debt Ceiling, in Pop Culture

Open Market

Enlisting readers in a hunt for answers.

During the financial crisis, the bank-run scene from “It’s A Wonderful Life” proved a useful pop-culture reference for helping people understand what was happening to the economy.

Enlisting readers in a hunt for answers.

This whole debt ceiling debacle and its potential consequences are similarly confusing, especially if you’re just tuning in now. It would be nice if there were a similar popular allusion to help people make sense of the debate. Yesterday I asked the Twitterverse for suggestions, and so far I’ve heard “Thelma and Louise,”  the end of “Planet of the Apes” and “Jackass: The Movie.“ Those aren’t exactly the kind of analogies I was looking for, but hey, they’re amusing all the same.

So readers, what do you think? Is there a film or other cultural touchstone that can help people understand the debt limit discussions and their potential consequences?

The Role of Government Spending

As Congress continues to wrangle over a debt reduction bill that will inevitably cut government spending, Friday’s estimates of second-quarter gross domestic product provided a sobering look at how a decline in public spending and investment can restrain growth.

G.D.P. grew at an annual rate of just 1.3 percent in the second quarter, according to the Commerce Department, well below consensus forecasts. First-quarter growth was revised down sharply to just 0.4 percent from an earlier estimate of 1.9 percent.

The astonishingly slow growth rate from April through June was due in large part to sluggish consumer spending and an increase in imports, which subtract from growth numbers. But dwindling government spending also held back growth.

While federal government spending increased by 2.2 percent in the second quarter, that was all because of a jump in military spending. Excluding military, federal government spending and investment fell by 7.3 percent, a much larger fall than in the previous quarter. State and local government spending, which has been a crimp on growth throughout most of the official recovery, fell by 3.4 percent.

The figures will inevitably put further pressure on Congress as it tries to come up with a plan and figure out just how many billions of dollars can be shaved out of the government’s budget.

“A weak economy will only make the tough decisions on the budget even more difficult,” Nariman Behravesh, chief economist at IHS Global Insight, wrote in a research note Friday, “and the case for fiscal austerity in the near-term even weaker.”

On the other hand, said Steve Blitz, a senior economist for ITG Investment Research, policy makers have to decide whether to continue to pump up the economy through government spending or figure out a way to spur the private sector.

“We are probably at as important an intersection of policy and the economy as we were in late 2008 and early 2009 when the economy was collapsing,” Mr. Blitz said.

Mr. Blitz favors reforming tax policy and aggressively pursuing foreign markets for American goods. But, he said, the only real prescription is to wait. With so many households still working off the debt accumulated during the boom years, he said, “that’s just going to take time to work out, and you can’t cheat the process.”

A US debt deal will be done, but it will offer only temporary respite

20 Freshmen of the House show their support for Boehner (Photo: Getty)

After another humiliating defeat for John Boehner’s bill, where are we now in the hunt for a compromise to head off US default and government shutdown? No nearer a deal, that’s where. It’s a quarter to midnight and House Republicans cannot even agree among themselves on the way forward, let alone reach an accord with the Democrat Senate. If there’s still nothing over the weekend, then we can expect markets, already jumpy enough, to be showing real signs of distress when they open first thing Monday morning.

After the markets have closed on Friday, the US Treasury is expected to announce details of what it intends to do in the event of failure to raise the debt ceiling. We have to assume it still plans to honour its debts above all other priorities. Even so, there’s talk of the Treasury preparing the ground for delayed payments. Whatever the contingency plans, the Treasury’s options are extremely limited.

There’s probably enough money left in the kitty to keep spending at current levels for a couple of weeks or so, but at some point it’s going to run out. When that happens, the Treasury will have no option but to move rapidly to bring spending into line with revenues. Almost overnight, an amount equivalent to some 8pc of GDP will have to be cut from spending.

Quite apart from the human grief this will cause in unpaid wages and bills, the effect on the wider economy would be utterly catastrophic. We are talking of an event of almost biblical proportions here. As the economy contracted, tax revenues would also plummet, and in little time at all the government would be chasing its tail down a downward spiral of cuts and falling tax revenues. At that point, default would become inevitable, however firmly the US might insist otherwise. The debt dynamics would be unsustainable.

It’s conceivable that the Federal Reserve could act to monetise the deficit by printing dollars to finance it, or simply cancel the government debt it already has on its balance sheet, but many would think that a default in all but name. These are nuclear options. The fallout would be extreme.

Once default is viewed as inevitable, the interbank lending market would freeze anew, prompting a second, global credit crunch on top of the violent contraction going on in the core of the US economy. It would be the 1930s all over again.

All this makes it pretty much unconscionable that a borrowing freeze will be allowed to happen. Somehow or other, a way will be found to raise the debt ceiling. It may not be by much, but it will buy a little time.

A sticking plaster solution is better than no solution at all, but it won’t address the US’s underlying fiscal problem and if the political stalemate continues in the meantime, we’ll only be back at the same point in six months to a year’s time. A credit downgrade already looks pretty much a done deal.

Uncertainty feeds economic stagnation, and so long as nothing is done to reach a lasting solution, decisions on whether to build that new factory, take on extra workers, or purchase the new automobile won’t get taken.

Dollar hegemony has been under threat for a long time now, but whatever the outcome of this latest political charade, it will come to be seen as a watershed moment when America finally lost the plot and condemned herself to lasting decline. Can a country that puts political bickering before the interests of economic and financial stability really be trusted with the world’s major reserve currency. I think not. The spell is broken. The age of the mighty dollar is over.

According to Winston Churchill, the US can in the end always be relied on to do the right thing, but only after all other possibilities have been exhausted. I wish we could be sure it was still true.

A US debt deal will be done, but it will offer only temporary respite.

After another humiliating defeat for John Boehner’s bill, where are we now in the hunt for a compromise to head off US default and government shutdown? No nearer a deal, that’s where. It’s a quarter to midnight and House Republicans cannot even agree among themselves on the way forward, let alone reach an accord with the Democrat Senate. If there’s still nothing over the weekend, then we can expect markets, already jumpy enough, to be showing real signs of distress when they open first thing Monday morning.

After the markets hace closed on Friday, the US Treasury is expected to announce details of what it intends to do in the event of failure to raise the debt ceiling. We have to assume it still plans to honour its debts above all other priorities. Even so, there’s talk of the Treasury preparing the ground for delayed payments. Whatever the contingency plans, the Treasury’s options are extremely limited.

There’s probably enough money left in the kitty to keep spending at current levels for a couple of weeks or so, but at some point it’s going to run out. When that happens, the Treasury will have no option but to move rapidly to bring spending into line with revenues. Almost overnight, an amount equivalent to some 8pc of GDP will have to be cut from spending.

Quite apart from the human grief this will cause in unpaid wages and bills, the effect on the wider economy would be utterly catastrophic. We are talking of an event of almost biblical proportions here. As the economy contracted, tax revenues would also plummet, and in little time at all the government would be chasing its tail down a downward spiral of cuts and falling tax revenues. At that point, default would become inevitable, however firmly the US might insist otherwise. The debt dyanamics would be unsustainable.

It’s conceivable that the Federal Reserve could act to monetise the deficit by printing dollars to finance it, or simply cancel the government debt it already has on its balance sheet, but many would think that a default in all but name. These are nuclear options. The fallout would be extreme.

Once default is viewed as inevitable, the interbank lending market would freeze anew, prompting a second, global credit crunch on top of the violent contraction going on in the core of the US economy. It would be the 1930s all over again.

All this makes it pretty much unconscionable that a borrowing freeze will be allowed to happen. Somehow or other, a way will be found to raise the debt ceiling. It may not be by much, but it will buy a little time.

A sticking plaster solution is better than no solution at all, but it won’t address the US’s underlying fiscal problem and if the political stalemate continues in the meantime, we’ll only be back at the same point in six months to a year’s time. A credit downgrade already looks pretty much a done deal.

Uncertainty feeds economic stagnation, and so long as nothing is done to reach a lasting solution, decisions on whether to build that new factory, take on extra workers, or purchase the new automobile won’t get taken.

Dollar hegemony has been under threat for a long time now, but whatever the outcome of this latest political charade, it will come to be seen as a watershed moment when America finally lost the plot and condemned herself to lasting decline. Can a country that puts political bickering before the interests of economic and financial stability really be trusted with the world’s major reserve currency. I think not. The spell is broken. The age of the mighty dollar is over.

According to Winston Churchill, the US can in the end always be relied on to do the right thing, but only after all other possibilities have been exhausted. I wish we could be sure it was still true.

Which Is in Worse Shape, U.S. or Europe?

Simon Johnson, the former chief economist at the International Monetary Fund, is the co-author of “13 Bankers.”

The United States and Europe seem to be competing hard this summer for the title of “biggest economic problem.” Based on the latest news coverage, Europe might seem to be experiencing something of a resurgence, as last week the euro zone agreed on a deal involving mutual support and limiting the fallout from Greece’s debt problems.

In contrast, the United States seems to be mired in a political stalemate that becomes more complex and confused at every turn.

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Perspectives from expert contributors.

But rhetoric masks reality on both sides of the Atlantic. The euro zone still faces an immediate crisis: the can was kicked down the road last week, but not far. The United States, on the other hand, is in much better shape over the next decade than you might think after listening to politicians of any stripe.

Perspectives from expert contributors.

American problems loom in the decades that follow 2021, so there is still plenty of time to sort these out; the bad news is that almost no one is talking about the real issues.

In a policy paper released by the Peterson Institute for International Economics on July 21, Peter Boone and I went through the details on the euro-zone crisis, including how this common currency area got itself into such deep trouble and what the likely scenarios are now (you can also see the discussion and contrasting views at the publication event).

In our assessment, the issue is lack of effective governance within the euro zone. Governments had an incentive to run reckless policy – either in terms of budget deficits (Greece), out-of-control banks (Ireland) or refusal to create an economic structure that would support growth (Portugal).

These policies were financed by loans from other countries, particularly within the euro zone, creating and sustaining the widely shared perception that if any country were to get into trouble, it would be bailed out by deep-pocketed neighbors (a phrase that in this context always means Germany).

At the heart of this system was a great deal of “moral hazard”; investors stopped doing meaningful credit analysis, so Greek or Spanish or Italian governments could borrow at just a few basis points above the rate for the German government (one basis point is a hundredth of a percentage point, 0.01 percent).

What has shocked investors’ thinking over the last three years are the realizations that Greece and some other “peripheral” countries have so much debt they may not be able to make all the contracted payments by themselves and that Germany and other northern countries have become convinced that foolish investors should suffer some losses.

Imposing losses on banks that made bad decisions is a sensible principle – but getting from here to there is not easy, particularly when the “periphery” includes Italy, with a far larger economy than Greece or Ireland or Portugal and with gross debt of nearly two trillion euros (about 120 percent of its gross domestic product).

Either Europe really ends moral hazard and widely restructures sovereign debts, or it keeps the bailouts coming, with the deep involvement of the European Central Bank, which will ultimately be inflationary. The package announced last week is a classic case of muddling through; it doesn’t really solve anything. (See the Economix Q. & A. on Greece’s latest debt deal.)

If Europe and the world now experience a growth miracle, these debt problems will recede in importance, because solvency is all about debt burdens relative to G.D.P. But if near-term growth is not strong, as seems increasingly likely, market participants will soon resume their contemplation of European dominoes.

In contrast, the United States has a simple fiscal problem – as I discussed in my testimony to the House Ways and Means Committee this week. Government debt surged from 2008, not because of Greek-style profligacy but rather because of an Irish-style banking disaster. When credit collapses, so does revenue. As the economy recovers, revenue comes back.

The single most interesting point about today’s debt ceiling debate is that over the 10-year forecast horizon that frames for the entire discussion, by any conventional definition no fiscal problem exists. In 2021, the United States is likely to have a small primary surplus at the federal level – meaning that the budget, before interest payments, will no longer be in deficit. (James Kwak elaborates on this point on Baseline Scenario, the blog we run together.)

The really bad budget numbers for the United States come after 2021, but these are not the focus of anyone’s current proposals on Capitol Hill. Compared with other countries, the increase in health-care spending from 2010 to 2030 is most troublesome and what will ruin us (see Statistical Table 9 in the International Monetary Fund’s Spring 2011 Fiscal Monitor; or, if you prefer a single picture that cuts to the chase, look at where the United States falls in Figure 1 on page 9 of the I.M.F.’s recent report on how to handle “fiscal consolidation” in the Group of 20 developed economies.)

The debate in Washington is both heated and off course, because no one is grappling with the difficult issue of how to control health-care costs. The Tea Party enthusiasts are intent on near-term government spending cuts as a condition of supporting any increase in the debt ceiling.

If this version of a libertarian tax revolt carries the day, the resulting fiscal contraction will slow the economy and fewer jobs will be created. It does nothing directly to address the looming budget issues beyond 2021.

In the near term, the Europeans have the bigger problem – and this will only be compounded by slower growth in the United States (home to about one-quarter of the world economy). Over the longer haul, it remains to be seen when and how politicians in the United States will take up the real budget issues.

So far, the evidence is not encouraging.

On Debt Talks, a Lose-Lose-Lose-Lose Situation

1:07 p.m. | Updated with a fifth (less likely) scenario.

Almost whatever happens this week with Washington’s debt talks, the economy will most likely be worse off.

As Dean Maki, the chief United States economist at Barclays Capital, put it: “The basic issue is that the U.S. is on an unsustainable fiscal track, which is pretty widely agreed upon. From that point, none of the choices are fun.”

CATHERINE RAMPELL

Dollars to doughnuts.

Here are the likely scenarios I see:

Dollars to doughnuts.

1) Held up by disputes over how to reduce deficits, Washington doesn’t raise the debt ceiling in time. As a result, the Treasury stops paying debts it owes.

If that happens, the rating agencies downgrade the United States’ debt. The cost of borrowing for the United States government shoots up, since lenders demand higher interest rates from borrowers that are less trustworthy. Many other interest rates are pegged to the cost for the United States to borrow, making interest rates on all sorts of other loans, like mortgages, rise too. Credit markets freeze up, crushing an already-feeble economic recovery.

Macroeconomic Advisers predicts that failing to raise the debt ceiling in time — even if the delay is only one month — will very likely result in a new recession. And because it’s more expensive for the United States to borrow, the United States debt gets even larger, the exact opposite effect from what fiscal hawks are hoping for.

2) Held up by disputes over how to reduce deficits, Washington doesn’t raise the debt ceiling in time. But rather than default on its debt, it diverts money from other spending into paying back bondholders.

That could mean that Social Security checks are not sent, soldiers in Afghanistan and Iraq are not paid, and all sorts of other consequences.

In addition, bond markets might still freak out because the threat of default remains, so interest rates could rise anyway and cause all the terrible consequences in Scenario No. 1 (potential second recession and even bigger federal debt).

3) Washington comes up with a deal to raise the debt ceiling, but it amounts to less than $4 trillion in savings.

Standard & Poor’s has said that just raising the debt ceiling is not enough; without a “credible” plan for at least $4 trillion in savings, the United States might still have its credit rating downgraded. That could, again, mean higher interest rates and all the other terrible consequences of Scenario No. 1.

4) Washington comes up with a deal to raise the debt ceiling that amounts to more than $4 trillion in savings over a near-term horizon.

The credit rating agencies are appeased, but such severe austerity measures put the fragile economic recovery at risk. The states in particular are anxious about what major spending cuts mean for them and for the many social safety net services they provide with federal support.

As Bruce Bartlett and others have written, similar fiscal tightening during a fragile economy happened in 1937. Those actions resulted in a severe second recession and prolonging of the Great Depression, partly because it was coincident with monetary tightening as well. While a sharp, sudden monetary tightening seems unlikely, the Fed is at the very least pulling back on its easy monetary policy with the end of its second round of quantitative easing.

As The Wall Street Journal’s Kelly Evans observed, Japan had a similar experience in 1998, when austerity measures were followed by a recession and a widespread sell-off of Japanese bonds.

And even if these likely American austerity measures don’t result in an outright recession, job growth is already so feeble that most Americans still think we’re in recession.

Imagine how terrible things would feel if the economy slowed down even further.

5) Washington comes up with a deal to raise the debt ceiling that amounts to more than $4 trillion in savings, but over a longer-term horizon.

This is the best-case scenario: It deals with the long-term unsustainability of the country’s fiscal arrangements — which is good for growth in the long run — but doesn’t rock the boat in the current economic recovery.

Unfortunately, it also seems to be the scenario that is least likely to be pulled off effectively.

Economists want spending cuts and/or tax increases that come after 2012, when the economy is expected to be stronger. But to use Standard & Poor’s lingo, cuts that take effect in 2012 may not be fully “credible.” Committing to future cuts/tax increases is just another way of kicking the can down the road, as Washington has been doing for decades now. Almost every time Congress promises painful fiscal measures at some future date, later politicians jump in to dismantle them just before they take effect.

“We do seem to have a time-consistency problem,” Mr. Maki said. “There does never seem to be a good time for major cuts, and they’re not going to be more popular five years from now versus now.”

He says that Congress must come up with a way to prove that these are cuts that will actually happen, versus something that’s on the drawing board and is therefore erasable.

Unfortunately, he says, “There is no way to completely tie the hands of future legislators.”

An Inconvenient Precedent for the Debt Crisis

CATHERINE RAMPELL

Dollars to doughnuts.

Last night, President Obama and the House speaker, John Boehner, gave dueling speeches on how to fix the deficit. One line from Mr. Boehner’s speech confused me:

Dollars to doughnuts.

Here’s what we got for that spending binge: a massive health care bill that most Americans never asked for. A ‘stimulus’ bill that was more effective in producing material for late-night comedians than it was in producing jobs. And a national debt that has gotten so out of hand it has sparked a crisis without precedent in my lifetime or yours.

The wording is a little ambiguous, but it appears that the “crisis without precedent in my lifetime or yours” refers to the current stalemate over the debt ceiling and the resulting threat of default.

With all due respect to Mr. Boehner, there is a precedent for this, and it was in his lifetime.

Mr. Boehner was born in 1949. In 1979 there was a showdown over raising the debt ceiling, and the country came within hours (not days) of defaulting on its obligations. In fact it actually did temporarily default on some of its obligations, although that seems to have been because of technical difficulties because discussions ran so close to the wire.

Brady Dennis of The Washington Post wrote a nice summary of this event earlier this month:

Congress had been playing a game of chicken with the debt limit, raising it to $830 billion — compared with today’s $14.3 trillion — only after Treasury Secretary W. Michael Blumenthal warned that the country was hours away from the first default in its history.

That last-minute approval, combined with a flood of investor demand for Treasury bills and a series of technical glitches in processing the backlog of paperwork, resulted in thousands of late payments to holders of Treasury bills that were maturing that April and May.

“You hear a lot of people say, ‘The government never defaulted.’ The truth is, yeah, they did. … It might have been small, it might have been inadvertent, but it happened,” said Terry Zivney, a finance professor at Ball State University who co-authored a paper on the episode titled “The Day the United States Defaulted on Treasury Bills.”

Conspiracy Theories About Republicans and the Economy

In the last few days, several readers, economists and radio hosts have asked me whether I buy the most cynical interpretation of the debt crisis stalemate: maybe Republicans are reluctant to raise the debt ceiling, or are calling for austerity measures that could slow the recovery, because they actually want the economy to do badly. That way voters will demand a change in political leadership, and vote more Republicans into office in 2012.

CATHERINE RAMPELL

Dollars to doughnuts.

I’m no political scientist, but that sounds a little too Machiavellian even for the most hardhearted of politicians.

Dollars to doughnuts.

But more important, I’m also reluctant to believe this conspiracy theory because the conspiracy isn’t necessary. That is, the economy is likely to be in bad shape in November 2012 no matter what happens with the debt talks.

As of January, the Congressional Budget Office projected that unemployment in the fourth quarter of 2012 would be 8.2 percent. Macroeconomic Advisers, another respected forecaster, recently published a similar outlook.

Of course, there are many outcomes to these debt negotiations that would make the economy even worse off than the current projections show. But really, there’s no need to paint the lily.