I am coming to the conclusion (not there 100% yet) that letting the country default may be preferable to the certitude of the safety net cuts.
We know the safety net cuts will do great harm to many. We know the safety net cuts are the ass-backward economic prescription for the country in its current economic state. We know the safety net cuts will take the legs out from under the democrats' campaign platform in 2012. We know the safety net cuts could destroy the democratic party. I also think the republicans want the safety net cuts, as long as the democrats are the ones who vote them in. I'm not sure the republicans would take the responsibility for them if left to their own devices. At least that has been the pattern. Welfare was destroyed under Clinton. Bush's effort to privatize social security went nowhere under republican governance.
So what about a default? We are in unchartered waters. Ezra Klein says the most immediate impact would be a rise in interest rates for everyone. Link: http://www.washingtonpost.com/...
And there would be a cash flow problem, requiring the treasury to allocate what revenues are coming in across many programs and obligations. I think current cash flow is about 44% of those obligations.
So, would this be worse for everyone?
I am not so sure.
First, just as with the government shutdown in in the 1990's, I think a default would be short-lived. If I am wrong about this, then ignore the rest of this diary.
Second, a default is all about market confidence. Low confidence, high interest rates, and vice versa.
But, to date, interest rates on US bond prices have not risen in reaction to a potential default. If we actually default, I would expect some rise, until Congress acted so as to stop the default.
Then what? Well, practically speaking, where else are investors going to go for safe investments in this world today? I'm not seeing it. This country is still huge economically speaking, we still have output, although reduced, and a lot of it. I'm not sure that the havoc of a default for a week or two would permanently and drastically shake the confidence of the world in the US economy, no matter what S&P and Moody's say. Remember, they also said that mortgage backed securities were safe investments. I am simply not sure how much power the credit rating agencies really have. Although I do recognize that a default is an opportunity for Wall Street and other rentiers to extract an increased risk premium, and I'm sure they'll figure that out. But they've also hedged against a default, so they'll make out like banditos either way.
A rise in interest rates may also give the Fed some room for actual monetary policy. As Krugman has incessantly pointed out, there just isn't much room when the real interest rate is effectively 0%. I'm only an armchair economist, having taken a few micro and macro courses at the graduate level, but I have yet to hear any discussion of this aspect of a default.
And the default could do great harm to the republican party. Obama too, no doubt, but I think the people know who has been behaving the worst in this situation. And it may end the hostage-taking dynamics that have plagued this administration.
When I weigh this against the certitude of the safety net cuts (and if not now because we get a "clean" debt ceiling increase, they will come soon, Obama has signaled as much, and the next opportunity is the 2012 budget fight), and the sick dynamics of hostage-taking and all that comes with that, I am not so certain that a default might not be the better economic course. And perhaps a better humanitarian course. Of course, that depends on the democrats finding their spines if a default happens. That worries me too, which is why I am not 100% sure yet.
Very sad, what a disaster. But we are where we are, and it is important to assess this. So, what do you think?
Update: I think Krugman does not necessarily disagree:
And failing to raise the debt limit could be widely read as a signal that we are, in fact, a banana republic.
In that case, however, what should Obama do? My answer is that despite all that, he must not let himself be blackmailed.
Partly that’s because once he gives in the first time, the blackmail will never stop. Once the crazies know that they can get whatever they want by threatening to blow up the economy, they’ll just keep demanding more and more. Obama just can’t let that dynamic get started without setting up an even worse crash down the road....
So giving in to the right would be just as much a signal of banana-republic-hood as a temporary default.
Link: http://krugman.blogs.nytimes.com/...
So please, stop attacking me personally for at least trying to consider the alternatives.
Update #2: Brad DeLong poses some possibilities of what could happen if the US credit rating is reduced:
The fact is that nobody knows what will happen to the Ten-Year Treasury yield if S&P downgrades the U.S. credit rating.
The interest rate on the Ten-Year Treasury bond could spike.
The interest rate on the bond could even fall--more chaos means a weaker global economy, and in a weaker global economy in the absence of inflation you should be holding more U.S. Treasury bonds, not fewer.
The interest rate on the bond could stay where it is, as the two types of fear offset each other.
The interest rate on the bond could stay where it is as markets laugh at S&P's chutzpah, at the institution that claimed that MBSs were safe now claims that U.S. Treasuries are risky.
Demand for U.S. Treasuries could fall, but the yield could stay the same as some other large actor--the People's Bank of China or the Federal Reserve--steps in and buys long-term Treasury bonds in order to sataiblize the market.
We simply don't know. My point is, this may be preferable to the destruction of the safety net, the appeasement of the hostage-takers, and the destruction of the democratic party's platform.