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.

Today’s Economist

Perspectives from expert contributors.

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.

Failure to meet the inflation target has been the fault of successive Chancellors, not the MPC

Osborne and Brown have ignored the target

Fathom Consulting argues that keeping CPI inflation down to 2 per cent would have come at the cost of risking more unemployment and deeper recession. Broadly speaking, I agree: it would have been a mistake to try to keep CPI inflation to 2 per cent. “Eh?“, I hear you cry.  “Weren’t you the one that wrote this and this and this, urging repeatedly that the Inflation Target has lost all credibility? Haven’t you been voting for half-point rises in interest rates at the Shadow MPC for about a year? Have you suddenly gone soft on us?”

Yes, I did write those things. No, I haven’t changed my position. You see, the fundamental problem with the UK’s monetary policy isn’t that CPI inflation is over 4 per cent. It is that it is 4 per cent when the stated target is 2 per cent, and there is no official admonishment of the Monetary Policy Committee. Credibility is about keeping to what you’ve promised, not about making the same promise every time. In the UK we use inflation targeting. Under an inflation targeting regime the authorities set a target level for inflation (state that they will try to get inflation to that target) over a particular time period: one year – every year the Chancellor of the Exchequer sets a new target for the forthcoming year.

The very essence of inflation targeting – what distinguishes it from other monetary policy regimes such as price-level targeting – is that the target can be set at a different level the next time you set it. The flexibility of inflation targeting and the concreteness of the periods of the target are its great virtues. Because the target is only for a year, we can look and see whether the target has been met, and then admonish the Bank of England if it is not. And because the target is for only one year (and because bygones are bygones – misses on past targets are not carried forward), we can change it to whatever target would now be appropriate.

The UK’s inflation target has been changed three times: the first target, which applied for a period of four and a half years from September 1992 to April 1997, was for inflation, on the RPIX measure (the cost of living excluding mortgage interest payments) to be between 1 and 4 per cent throughout the period to the end of the 1992-97 Parliament, and between 1 and 2.5 per cent by the end of the Parliament in April 1997. That target was always met. The target was changed in 1997, in three ways. First, that it should apply yearly instead of over a Parliament. Second, that there was to be a continuous preference for the centrepoint of the range, at 2.5 per cent, rather than a preference for the lower half of the range (as before). Third, that the range would be reduced to 1.5-3.5 per cent (instead of 1-4). That target was always met.

The target was changed again in 2003. As part of trying to achieve convergence with the euro area (so we could join the euro – this was explicitly the reason) the measure of inflation was changed to the European Harmonised Index of Consumer Prices (HICP), as used by the European Central Bank. We re-baptised the HICP the CPI, and set the preferred centrepoint of the target at 2 per cent, with the new range being 1 to 3 per cent.

The third time the target was changed was less formal than the other two. In April 2007, for the first time in its fifteen year history, the UK missed its inflation target, with CPI inflation rising at 3.1 per cent. Mervyn King was forced to write a letter to Chancellor Brown explaining why. Given that this was a target miss, one might have expected the Chancellor to admonish King, to tell him he expected the target not to be missed again, to ask for a detailed rectification plan. But, what with being about to take over from Tony Blair as Prime Minister and not wanting to leave as Chancellor on a sour note, Brown did no such thing – setting a precedent, for no subsequent Chancellor has admonished the Governor for any miss, either. Instead, the Monetary Policy Committee went around making speeches explaining that we had all “misunderstood” the inflation target, and that actually there was no requirement to keep inflation below 3 per cent or above 1 per cent. Of course, we hadn’t misunderstood at all. But because the Monetary Policy Committee was permitted by the Chancellor to do this, the target was effectively redefined – not, this time by the Chancellor, but instead by the Bank of England. The new target was for CPI inflation to be 2 per cent, with no constraint over how far inflation should be permitted to deviate from this 2 per cent figure in the short term.

Since the inflation target has explicitly been changed twice (and in practical terms changed a third time), it obviously can’t be unthinkable to change it. In 2008, and again in 2011, I and a few others urged that the target should be changed again. Since it would be undesirable to try to get inflation to 2 per cent – Fathom is right about that – the target should either (a) have been set, for the year to come (2008 or 2011) at a level that was desirable (e.g. perhaps 4 per cent); or (b) the target should be changed back to one that included a maximum level by which inflation was permitted to deviate from the target in the short-term – e.g. by saying that for the year April 2011 – March 2012, the target is 2 per cent, and inflation should be no more than 5 per cent and no less than 1 per cent, even in the short term. Either way, once announced at a credible level, the target should be enforced.

The failure to set a target one wants the Bank of England to try to meet, rather than a target one hopes they will not try to meet, is down to the Chancellor of the Exchequer, not the Bank of England. It is for the Chancellor to set the target and to hold the MPC accountable for meeting. When I say the Bank of England lacks credibility, I am not saying it would have been better if inflation had been 2 per cent – with all that would have entailed. I am saying that the inflation target should have been (and should now be) set at a level the Chancellor desires and is willing to enforce.

How to Ruin Italy

Italy is the victim of an entirely inappropriate monetary policy.

The country needs ultra-loose money to offset €48bn of fiscal tightening and stave off a bond crisis. Instead it gets this, (from the Banca d’Italia):

Italy’s real M1 deposits have been contracting at a 7pc rate over recent months, and M3 is not far behind. This is catastrophic.

The ECB could prevent such a downward spiral. It chooses not to do so, and is therefore pushing Italy ever closer to the brink. (Yields have fallen slightly today on the relief rally from the US debt deal, but 10-years are still unsustainably high at 5.71pc).

This ECB policy risks a global systemic crisis. Italy has a public debt of €1.84 trillion, the world’s third largest after the US and Japan.

Fairly or not, Italy and Spain are chained together in this storm so the problem is in reality even bigger. The pair must be treated a single unit in systemic financial terms.

German M3 is growing at 8pc, but surely the ECB is not going to set policy for German needs and blow up the European financial system in the process? Or is it?

Debt crisis averted, stock market focus will turn back to economy

The U.S. stock market lately has felt a lot worse off than it really was.

That’s the backdrop as the new trading week begins, with Congress and the White House apparently in a deal to raised the federal debt ceiling ahead of Tuesday’s cash-crunch deadline for the Treasury.

July was the third straight losing month for equities, but key indexes haven’t given up a huge amount of ground despite the debt drama in Washington and a barrage of weak economic data in recent weeks.

The Standard & Poor’s 500 index (charted below) fell 3.9% last week to end Friday at 1,292.28. But it’s down a modest 5.2% since reaching a multiyear closing high of 1,363.61 on April 29.

So the decline so far doesn’t even qualify as a garden-variety “correction” in a bull market. A typical correction knocks 10% to 20% off market indexes. A drop of more than 20% would constitute a new bear market.

The market last week continued the trend in place since major indexes peaked in April: The selling has been concentrated in shares of companies that are most sensitive to the economy’s swings. That has been offset by much smaller losses in shares of companies whose businesses are less cyclical in nature.

The point being: If you have a diversified portfolio, this pullback has been a hiccup so far. That was true at the market's recent lows in June, too.

Of the 10 major industry sectors in the S&P index, industrial stocks have fallen the most since April 29, down an average of 10.6%. That group includes names such as Boeing, Deere & Co. and 3M Co.

Other sectors that have been hit hard include financials (down 9.7% on average since the April high) and basic-materials shares (i.e., commodity producers), off 6.6%.

Meanwhile, the utility sector within the S&P index is up 0.02% since April 29. Utilities are classic “defensive” stocks, meaning they tend to be a good place to hide amid market turmoil. Their above-average dividend yields also are a draw.

Another defensive sector that has held most of its ground is the so-called consumer staples group, which includes companies such as tobacco giant Altria Group, cereal maker Kellogg Co. and drugstore chain CVS Caremark. That stock sector is off just 2.2% since April 29, on average.

Stocks of smaller companies have fallen faster than blue chips over the last week, month and three months, but that’s typical when the market weakens. Yet small-stock indexes also are down less than the "correction" threshold of 10%.

The Russell 2,000 small-stock index (charted at right) slumped 5.3% last week. It’s down 7.9% from its 2011 high reached on April 29.

The S&P 400 index of mid-size company stocks lost 4.9% last week and is off 7.1% since April 29.

Assuming the federal debt mess is resolved, investors are likely to focus more intently on the economy’s prospects. So far, strength in second-quarter earnings at many companies has largely offset concerns about  faltering U.S. growth apparent in much of the economic data.

This week, Wall Street will get key reports on the economy in July, including the ISM manufacturing-sector index (due Monday), car sales (Tuesday), the ISM services-sector index (Wednesday) and the all-important employment report (Friday).

With stocks holding on to most of the hefty gains they’ve racked up over the last year, the market clearly doesn’t believe what much of America believes -- that another recession (or worse) is looming.

This week’s data may help show who’s got it right on the economy as the U.S. debt drama recedes.

-- Tom Petruno

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Asian stocks rally, gold falls as Congress sets debt deal

Stocks jumped in Asia as the new trading week began after Democrats and Republicans reached a deal to raise the U.S. debt ceiling and cut spending.

Gold fell and Treasury bond yields edged up. The dollar was mixed.

The Tokyo stock market’s Nikkei-225 index was up 180 points, or 1.8%, to 10,012 about two hours into the trading day Monday. Australia's main share index was up 1.9%, the South Korean market gained 1.7% and Hong Kong was up 1.5%.

Stocks had been pounded worldwide last week in part on fears that the U.S. might default on its debts. On Wall Street the Dow Jones industrial average fell 4.2% for the week, its worst loss in a year.

Resolving the debt crisis would remove one stumbling block for markets. Now, investors are expected to shift their focus back to the global economy, which has weakened substantially in recent months.

But for the moment, at least, investors are pulling back from some of the classic havens that attracted money as Washington’s debt drama worsened.

Gold futures fell $13 to $1,615 an ounce in electronic trading Sunday evening, after reaching a record high of $1,628.30 on Friday in New York.

The yield on the 10-year Treasury note rose to 2.83% from 2.80% on Friday.

Despite worries about possible default -- something that was never a serious risk in the eyes of many analysts -- Treasury yields had plunged on Friday after the government gave a dismally weak estimate of second-quarter economic growth.

That showed that, even as Congress’ gridlock over the debt ceiling put the world on edge, Treasuries were retaining their role as a place for capital to hide in times of economic uncertainty.

-- Tom Petruno

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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?

Used cars, immigration lotteries: Your weekly ScamWatch

Here is a roundup of alleged cons, frauds and schemes to watch out for.

Used cars –- Consumers should take caution to avoid fake dealerships when purchasing used cars on the Internet, the Better Business Bureau said in a news release. Some con artists are setting up websites for fake dealerships, requesting deposits and then failing to deliver the cars, the BBB said. Michelle Corey of the BBB said consumers should take caution when paying in advance for anything marketed on the Internet. She suggests consumers purchase only from well-established businesses with solid reputations. They also should use credit cards whenever possible in case they later need to challenge the purchases.

Immigration lotteries –- Immigrants living in the United States have been targets of a scam in which they receive emails that claim they have won lotteries to receive U.S. immigrant visas. The emails include an official-looking State Department letterhead and request payment of $819 through Western Union to a company in London, said Paul Young Choi, an immigration lawyer in Encino. Immigrants who receive such emails should ignore them, Choi said. He notes that U.S. government agencies do not send invoices by email requesting payment to third parties in foreign countries.

Online “Yellow Pages” –- A European-based operation has bilked U.S. small businesses, churches and nonprofit organizations out of millions of dollars through phony bills for online advertising, the Federal Trade Commission has alleged. The operation, based in Spain, England and the Netherlands, sends invoices to U.S. offices for online advertising they did not want and then refuses to issue refunds to companies that discover they’ve been duped, the FTC alleged in a lawsuit against several companies, including Yellow Page Marketing Yellow Publishing and Yellow Data Services.

-- Stuart Pfeifer