Response to Joe Weisenthal’s Critique of My Politico Opinion Piece

Yesterday I had an op-ed in Politico suggesting that U.S. lawmakers should consider not raising the federal debt limit (at least for now). I argued that freezing the ceiling would assure investors that the United States is serious about reducing its debt, and that it would serve as a commitment device for lawmakers and President Obama to forge and follow a serious debt-reduction strategy.

A financial website writer named Joe Weisenthal strongly disagreed with my column. He seems to misunderstand several of the points that I was making, and so I offer the following response to his comments:

From Weisenthal’s post:

Another day, another economist advocating that the US default on its debt.

The latest is Jagadeesh Gokhale of the Cato Institute, who has a big piece advocating an immediate freeze of the debt ceiling.

It's so convoluted, we hardly know where to begin, but let's just address a few sloppy parts.

Many knowledgeable federal officials, like Treasury Secretary Timothy Geithner and Federal Reserve Chairman Ben Bernanke, as well as left-leaning lawmakers, insist that the answer lies in lifting the debt limit. They warn Congress about the dire consequences if it fails to do so. President Barack Obama has chimed in — though he voted against raising it when he was a senator.

They all assert that failing to increase the debt limit could sharply undermine the economic recovery.

But that view could be wrong. A temporarily frozen debt limit could instead signal U.S. lawmakers' resolve to get our fiscal house in order. It may even reassure investors about long-term U.S. economic prospects.

This line about "reassuring investors" is nonsense. Investors are already reassured, which is why interest rates have only fallen amidst all the squawking from the political class about this "crisis."

From the start, Weisenthal doesn’t follow my argument. I am not concerned about the state of market confidence today, but what it would be if the debt limit were frozen. The contrarian view that I expressed in my op-ed is that participants would interpret a debt-limit freeze positively, just as they appear to have interpreted the recent downgrade of the U.S. economic outlook by Standard and Poor's positively — U.S. equities, U.S. treasuries, and the dollar are up less than 48 hours after S&P's downgrade announcement.

He also misunderstands why interest rates have declined. It is because of the Federal Reserve's sustained intervention in bond markets, not because there is little investor concern over the United States’ long-term fiscal outlook.

Returning to Weisenthal’s post:

He then gets to the discussion of a default.

...the current prospect of a technical default, from failing to increase the debt limit, would not be due to any real national insolvency. Given today's low interest rates, the federal government could easily raise the resources needed to meet today's contractual government obligations.

This doesn't make any sense. How do "low interest rates" matter to the government in a situation where it's legally unable to borrow?

Here, Weisenthal misunderstands what it means to freeze the debt limit. It does not mean, as he believes, that the government is “legally unable to borrow.” It only means that the government cannot issue any additional debt beyond the limit. But the government can (and will) continue to roll over its existing debt, and must do so at current interest rates, which makes those rates relevant to the discussion.

More Weisenthal:

Anyway, here's the biggest whopper of them all:

How might investors really view this ersatz U.S. debt crisis? If some lawmakers' refusal to vote for increasing the debt limit without also passing prudential fiscal policies resulted in a technical U.S. default, it would demonstrate their significant political strength.

Might that not actually induce investors to buy long-term U.S. debt — reducing long-term interest rates and improving the U.S. investment climate?

Oy, where to begin? First of all, the notion that a "technical default" would induce investors to buy long-term U.S. debt is prima facie absurd.

Perhaps he knows something I don’t, but I don’t see this as absurd at all. I’d expect that a serious commitment by political leaders to get the nation’s fiscal affairs in order would inspire investor confidence in U.S. securities. If anything, it’s absurd to think that investors would be encouraged by Weisenthal’s preferred policy of the nation continuing to expand its borrowing without a plan to manage its debt.

Back to his post:

Second, as we stated above, longterm US interest rates are at historical lows, so the idea of needing to reduce them further to improve the US investment climate is rubbish. And finally, why do we want people to buy more long-term US debt? Ideally we want people going out and actually investing in things with their money: companies, employees, lending to corporations, etc. Aren't debt hawks supposed to hate the idea of government borrowing crowding out private spending. [sic]

The problem with this comment is that today's historically low interest rates are not a reflection of freely operating market forces. They result from the Fed's massive interventions through its Quantitative Easing policy.  The Fed has increased its portfolio of market assets — now approaching a staggering $2.7 trillion — in part by purchasing treasuries with longer maturity than it used to purchase before 2008. Without that injection of liquidity (note to Ben Bernanke: I didn't say the Fed is "printing money"), market rates would be much higher.

Weisenthal does rightly worry about the effect of U.S. government finance on other sectors of the financial market. Fortunately, investors are beginning to branch out beyond government securities. But even as the Fed has been purchasing so many Treasuries to keep interest rates artificially low and fund the government, it has also purchased private assets because investors have not been buying U.S. private assets as much as they used to. The Fed has been propping up particular U.S. sectors (e.g., securitized finance, insurance, auto, home, credit card loans) to keep them from failing. If you removed the Fed's $2.7 trillion liquidity injection from markets, interest rates would be much higher today. (How the Fed should conduct monetary policy is a different topic, beyond the scope of this post.)

Government officials are afraid that investor exits from Treasuries (and U.S. assets in general, both government and private) will accelerate if the debt limit is frozen, as I mentioned in the Politico article. I'm suggesting that view might be incorrect.

Weisenthal concludes:

Basically, Gokhale is just throwing a bunch of stuff at the wall, failing to produce an argument, and hoping you don't really get it. Sorry.

Respectfully, I think my argument is quite coherent, though I admit it’s not the conventional view offered by many other commentators. Indeed, that’s why I wrote the op-ed.