What a difference a dozen years makes.
When Republicans took control of the House of Representatives during a Democratic presidency 12 years ago, they were riding the wave of populist Tea Party anger over bailouts. Yet despite a host of upstart newcomers, they managed to pull together when it came to electing the Speaker of the House. Rep. John Boehner (R-Ohio) won all but one GOP vote in the 112th Congress, his own, which he declined to vote for himself.
The Republican agenda at the time was steeped in Tea Party concern over the debt and deficits the US government had incurred as a result of the financial crisis and the Great Recession. Although President Barack Obama’s 2009 stimulus package appears quite modest considering the spending incurred during the pandemic and the first year of the Biden administration, at the time it was widely seen as alarming by Republicans. and the self-employed who considered themselves fiscally responsible.
To limit spending, Republicans have promised not to raise the debt ceiling unless it is coupled with spending limits. It culminated in a summer showdown between President Barack Obama and the Republicans that was – or at least appeared to be – extremely disruptive for financial markets. Between July 29 and August 8, the S&P 500 plunged 17%. Although the two sides were able to reach an agreement suspending the ceiling, Standard & Poor’s expressed disapproval of fighting the debt ceiling by lowering the credit rating of US debt.
Financial markets disagreed that U.S. government debt had proven riskier as a result of the fight. Rather than plunging after the loss of the triple-A rating, Treasury prices rose after the downgrade. Investors looked around at a world fraught with risk – European sovereigns were stumbling through their own debt crisis, for example – and decided they liked the safety of US government bonds, no matter what. S&P ratings managers. Rightly, many viewed S&P’s rating change as a political statement rather than an assessment of financial risk.
A friend at the time pointed out that it was indeed impossible for US government debt to be downgraded. The United States is the largest economy in the world, and the US Treasury bond market is the largest financial market in the world. This means that treasury bills are, almost by definition, the safest financial assets out there. Everything else is reduced in US government debt from slightly riskier to much, much riskier. If US government debt becomes slightly riskier for one reason or another, all other financial instruments also become riskier. To paraphrase an old joke about the Soviet Union: in the United States, you don’t downgrade Treasuries. Treasurys demote you.
The current fight among Republican lawmakers over who will be Speaker of the House has implications for the debt ceiling debate we’re likely to have later this year. The limit was raised in December 2021 from $2.5 trillion to $31.381 trillion, which is expected to last until at least July 2023. As we learned in previous episodes, this is not the end of the government’s ability to continue its operations. when revenue is less than expenditure. The Treasury is able to engage in various “extraordinary measures” to avoid having to issue debt for several months.
Wall Street and many political analysts in Washington, DC are confident that Republicans won’t “play chicken” with the debt ceiling this time around. After all, the GOP is increasingly dependent on the votes of senior citizens, and Democrats are sure to argue that the US government’s inability to issue new debt will put Social Security and Medicaid at risk. Many GOP leaders believe the fight against the 2011 debt ceiling did not help the party and may have contributed to the loss of the 2012 presidential election, despite overwhelming evidence that Mitt Romney and Paul Ryan were very effective in destroying the GOP’s chances of winning the White House on their own.
Note that the leadership of the Republican House does not want a bloody fight against the debt limit. What the President’s chaos tells us is that maybe it doesn’t matter. There is at least a vanguard of Republican representatives who are prepared to fight, especially on issues of government spending. Moreover, in our age of runaway inflation, the case for controlling spending and deficits is much stronger than it was in 2011. If it ever made sense to listen to the rule of the constitution that debt must be authorized by Congress makes sense now that we have spent and borrowed to enter an inflation crisis.
Financial markets are currently blithely assuming that 2023 and 2024 will be years of legislative gridlock, but no where near with a U.S. government legally prohibited from issuing debt to pay for authorized spending. At the very least, we believe this is currently an undervalued risk for the markets.