Hi everyone. Welcome to another Monday edition of What Now? — this time, we’re talking economics.
Wait. Stop. Please don’t leave. Don’t worry, it won’t be me talking economics to you. Instead, we’ve got a tidy little interview with Alex Yablon, a columnist for Business Insider and regular freelancer who writes a newsletter about political economy and monetary policy. The reason I’m talking to Alex is that he’s a pal and I wanted to do an interview this week, but also because Congress is heading into one of the most fiscally chaotic and confusing weeks that I can remember.
Right now there are two big spending fights going on in Congress: one is the (proposed) $3.5T reconciliation bill, and the other is a linked combination of raising the debt limit and authorizing new government spending for the next fiscal year. (We’re not worrying so much about the infrastructure bill because it already got hacked down by the “bipartisan” people.) Any of these issues alone would be a massive story, but we’ve basically combined all of them into one big political battle.
Alex has written two really sharp pieces recently, one for the New York Times and one for Slate, that both advocate for the government using its power to lend money to local municipalities and nonprofits to accomplish its big goals on climate change and beyond — maximizing the Biden admin’s ability to go after its goals in the most efficient way possible. He’ll get into that and also explain some of the consequences of what the current chaos in Washington could cause. Let’s jump in.
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Discourse Blog: It’s absurd that we do a stupid little dance over government spending every single year, which inevitably turns into a political fight that threatens to fuck up the lives of thousands of Federal workers.
Alex Yablon: The debt ceiling is essentially a leftover from the 18th century. The Constitution requires Congress to approve every single time the government takes on debt, in an effort to deliberately restrict the growth of the central state. Many pre-revolutionary European absolute monarchs had gotten their countries in trouble by running up unsustainable debts, which they paid for with taxes on the increasingly prosperous bourgeoisie. This is what the founders were afraid of when they created a debt limit— they wanted to protect the property of taxpayers from a potentially spendthrift central government’s financing needs.
But by 1917, we’d been through a Civil War, established ourselves as an incipient global empire, had a national infrastructure network, and got involved in the First World War. The government simply had too many financing needs to wait for Congress’ approval each time we borrowed to pay for projects the legislature had already passed into law. The debt ceiling was created in 1917 as a temporary workaround to that 18th-century restriction on borrowing: Congress then authorized the federal government to borrow up to a certain point to cover costs that had already been approved, with the expectation that the ceiling would just be raised as need be, or perhaps that once WWI ended America would no longer need to finance large spending projects.
With the benefit of hindsight, of course, we can see that when America decided to make itself a genuine federal government in the early 20th century, it should have just abolished this relic intended to keep tax bills low for revolutionary-era merchants and landowners.
DB: So this year, Pelosi has linked that fight to something more destructive, which is raising or suspending the debt limit (which has been on pause since 2019). If Congress can’t pull that off, the U.S. could default on its loans by mid to late October. What uh… what happens then?
If the US truly defaults on Treasury loans, the world would be in completely uncharted territory. That’s because Treasury bonds are the absolute bedrock of the global financial system: investors hold more than $21 trillion in US debt because it is the safest interest-bearing asset in the world. After all, treasury bonds pay interest in dollars, and the US government has the only legit dollar printer in the world. There’s no good reason America should ever default on its dollar debt. Knowing this, investors use treasury bonds as the safest collateral against which they take on debt themselves or issue loans. If anything goes terribly wrong, investors know they’ll be able to sell their treasury bonds to quickly raise cash, since there’s an insatiable global demand for safe interest-bearing assets.
If we default on that debt without quickly taking action to undo the damage, however, then market participants have to throw those assumptions out the window. Suddenly our bonds are terrible collateral. Owners of our debt will scramble to sell them all at once, crashing the price in a vicious cycle. As the value of US debt falls, banks (who can make loans only in a certain proportion to the value of the “tier 1” risk-free capital they hold) will have to call in loans, leading to bankruptcies. Traders who make bets using borrowed money with safe assets like Treasuries as collateral — the “leverage” on which the financial system runs — will get wiped out, because the collapsing value of their collateral will no longer support their borrowing. This could spark a generalized financial panic.