Commentary
Last week’s struggle in the House of Representatives to select Kevin McCarthy (R-Calif.) as speaker of the House is probably the most contentious House battle most of us will see in our lifetimes. But there is another one coming that is far more important: the battle over the debt ceiling, which will be looming over Congress late this summer or early fall.
Background
The United States is $31 trillion in debt; that’s more than 120 percent of the annual U.S. gross domestic product (GDP). Projections show that spending will exceed revenues by at least $1 trillion per year, every year, for at least the next 10 years. While the debt-to-GDP ratio has decreased from pandemic levels—and the ratio was exacerbated due to the pandemic recession decreasing GDP—it still remains well above pre-pandemic levels—levels that were, even then, historically high. Moreover, neither the debt nor those trillion-dollar a year projections take account of U.S. obligations for entitlements like Social Security and Medicare, which are funded through their respective trust funds and which are also fiscally unsustainable.Our national credit rating is the sine qua non of U.S. sovereign economic power. Money in U.S. Treasurys, bought from around the world, is considered (almost) “as good as gold.” The United States has never defaulted on its debt, going back to Alexander Hamilton, the first secretary of the Treasury. The rate of interest paid on U.S. Treasury obligations is, thus, the baseline—i.e., the risk-free rate—in determining interest rates in the nation and, largely, around the globe.
That’s because the U.S. dollar is the world’s reserve currency, at least for now. Our extensive, transparent, and highly regulated securities markets; our rule of law; our enormous economy; and the fact that most oil is priced in dollars makes us the safe place for investors from around the world to invest. We are the world’s financial hegemon. That has, in turn, allowed us what was once called “an exorbitant privilege“; meaning, the ability to obfuscate our chronic balance-of-payments deficit in trade by exchanging hard imported assets—goods, commodities, and services—in exchange for U.S. debt obligations instead of our own exports. The world’s producers happily exchange the dollar they obtain selling us their cars, electronics, oil, sneakers, clothing, and other goods and services for U.S. Treasurys (as well as U.S. farmland, real estate, and companies). Someone once said that Sony Corp. bought Columbia Pictures with the profits the Japanese electronics giant earned from its 1980’s hit personal stereo gadget, the Sony Walkman.
But maintaining the status of the U.S. dollar as the world’s reserve currency, and that “exorbitant privilege,” requires astute and assiduous stewardship; once lost, it is unlikely to ever be restored. Beyond the fiscal consequences, which would be devastating, losing the status would have destabilizing, and potentially dangerous, geopolitical consequences around the world. (Imagine, for example, if the dollar were to be replaced by the Chinese renminbi as the world’s reserve currency. U.S. economic sanctions would be almost meaningless.) Even the less onerous prospect of the U.S. dollar becoming part of a basket of currencies (the U.S. dollar, euro, yuan, yen, and sterling are the “basket” components most discussed) would result in an enormous diminution of U.S. financial and geopolitical power and influence. (Having the U.S. dollar replaced by such a basket was once naively suggested, with disastrous consequences, by former Treasury Secretary Tim Geithner, and quickly walked-back.)
Between Scylla and Charybdis
Like Odysseus in the Odyssey had to navigate between two dangers, the kind astute and assiduous stewardship of the U.S. dollar as a reserve currency will require budget-conscious conservatives in Congress to navigate a narrow political, fiscal, and economic strait to resolve the conflict with their more spendthrift colleagues, including many among them for whom the defense budget is inviolate. On one side is Scylla—the risk that a prolonged fight over the debt ceiling will result in a further downgrade in the credit standing of the United States, as occurred in 2011. On the other side is Charybdis—the risk that continued reckless over-spending and continuing trillion-dollar deficits will cause a sovereign debt crisis that, in itself, causes global investors to lose confidence in the U.S. dollar so that they seek out alternatives as the reserves. (The U.S. dollar has already dropped to a 25-year low as the reserve currency most held by foreign central banks by the fourth quarter of 2020, according to the International Monetary Fund.)The debt ceiling debate will be the most contentious and consequential debate in the 118th Congress, and one that will divide Americans even more, I suspect. It will be fractious among Republicans particularly, given the need for reductions in Defense Department spending and spending oversight reforms.
Sealing the ceiling deal will require some “adults in the room” as we the address the twin looming catastrophes of a sovereign debt downgrade or default and a sovereign debt crisis in which the world loses confidence in the U.S. dollar.
As the matter progresses, I will weigh in here from time to time with some thoughts of my own as to how Congress can avoid the rocky fiscal shoals.
