Aamerica is once Once again in the grip of debt-limit crisis. If there is no deal between Congress and the White House, the government could run out of cash, and could be on the verge of a sovereign default in just weeks’ time. Most investors expect last-minute compromises to avoid the financial Armageddon seen during past crises. Yet the positions on each side of the aisle look confused: Republicans want big spending cuts; Democrats are protesting. So the White House must consider its break-glass options. What will President Joe Biden do if there is no agreement?
There are two broad types of workarounds—one magical, the other messy and neither attractive—that the Biden administration could use to manage the fallout from the debt-limit disaster.
Start with the actions that would at least theoretically present a debt limit dispute. One that has captured the imagination of Wonks because of its novelty is the trillion-dollar coin. The Treasury may mint commemorative coins of any denomination. It was first suggested on a blog in 2010 that it should be made a highly valuable coin, deposited into the government’s account at the Federal Reserve and used to pay for everything from military pay to scientific research. The government would no longer need approval from Congress to borrow. In fact, it will no longer need to borrow from the public markets.
Another idea is that the White House could invoke the 14th Amendment to the Constitution, which states that the legality of US government debt “shall not be called in question”. The Biden administration could issue an executive order citing the 14th and directing the Treasury to resume bond issuance. As long as it is upheld in court, the White House will continue to declare the debt ceiling unconstitutional and give itself a free hand.
A final magical solution would involve financial engineering. The loan limit specifically targets the face value of the loan. At current yields, the Treasury can borrow money for two years at an annual rate of about 4%. But what if it offered a bond with a coupon of 100%? In this case it can issue bonds for about 1/25th the face value of a bond with a 4% yield, but raise the same amount from investors (who will pay a huge premium to face value, thereby reducing the bond’s true market value). rate yield). Since the Treasury rolled existing loans into high-coupon, low-face-value bonds, it would gain plenty of space under the debt ceiling, allowing it to resume borrowing.
These magical workarounds are all clever. Yet they share the same basic flaw. They are, to varying degrees, trickery and loopholes that do not seem appropriate for US government bonds, the world’s most important financial asset. It would be preposterous to think that the Treasury—a benchmark for interest rates and a safe haven for investors around the world—could be dethroned by a commemorative coin. Treasury Secretary Janet Yellen has dismissed the option as a “gimmick”.
Although gimmicks would be better than the US government reneging on its debts, there is another objection to such magical solutions: Each would be subject to legal challenge, sowing uncertainty in the markets. Some experts believe the administration could win the 14th Amendment case. But in a Supreme Court with a conservative majority, that’s not certain. Legal proceedings may extend beyond that time, perhaps as early as June, in case the government runs out of money. Stuck in litigation, Magical Solutions will struggle to contain the vagaries of the market.
That would leave the US with a trickier, more painful solution: the priority of payments. The Treasury would set aside cash from its tax revenue to make the interest payment. Whatever money is left, he can meet some of his other obligations. Analysts at think-tank Brookings Institution forecast the result would be a one-quarter cut in government non-interest spending, which would represent a remarkably harsh dose of austerity. If the government were to aim for an extra layer of priority—making Social-Security payments to retirees, as well as covering its interest on bonds—it would have to cut other spending by about a third.
Fed and Treasury officials have already begun planning for prioritisation, a blueprint laid out during the debt-limit crisis in 2011. Still, Treasury officials privately admit they don’t believe the priority will work. For this plan to work, the government would have to continue selling bonds on a regular basis, using the proceeds to pay back the principal from maturing bonds. That would require dealers to show up as frequently as four times a week for Treasury auctions, sometimes with billions of dollars on the line, and play their part in priority tap-dances. What happens if they hesitate and believe the environment is too uncertain?
Politics will also be treacherous. Putting bondholders ahead of civil servants, pensioners and soldiers “may not prove sustainable”, as Bill Dudley, then president of the New York Fed, dryly noted during a plan discussion in 2011.
Despite all the obvious flaws, if Congress doesn’t lift the debt ceiling in time, the priority will almost certainly fall early. “A few days of priority may be all it takes for both sides to wink,” says Dilip Singh, a former economic adviser to the Biden administration. “It will cost big and hopefully crystallize in the mind DC, a deal breaker. Whatever the outcome, one conclusion is clear: This is no way to manage the world’s largest economy.
Sign up for more expert analysis of the biggest stories in economics, finance and the markets money TalksOur weekly subscriber-only newsletter.