The Treasury's Aug. 2 deadline for reaching the federal borrowing limit is rapidly approaching, but prospects of a budget deal remain unclear.
House Republicans seem resolved to shun compromise until that deadline, perhaps until well beyond it. But dire warnings about financial Armageddon if the deadline is breached seem vastly exaggerated.
As House Republicans proceeded to pass their Cut, Cap, and Balance legislation, President Obama has shifted his position with increasing frequency. He initially painted himself into a corner by ruling out a short-term budget deal. Later he embraced the McConnell plan, only to soon switch in favor of the Gang of Six approach.
He now appears to be backed into a corner, suggesting a temporary stop-gap measure would be acceptable "if it is tied to an agreement by both parties on a broader deficit-reduction deal" — whatever that means.
House Republicans appear steadfast in rejecting all deals between Senate leaders and Obama that include tax increases and do not include a balanced budget amendment to the U.S. Constitution. They ask why such an amendment to ensure that we never return to a similar fiscal precipice is so unreasonable when Americans must do the same — a question that resonates with their constituents.
And they strongly believe that pushing the deadlock through Aug. 2 will only increase their leverage with the president and other leaders.
But House Republicans also risk being characterized as unreasonable and intransigent — if prognostications by administration officials of a financial Armageddon after Aug. 2 without a higher debt ceiling prove true. Do such dire warnings have much merit?
Markets view U.S. treasury securities to be the safest of all financial securities because the U.S. is considered to be most resilient of economies. This also confers reserve currency status to the U.S. dollar, reducing the price of foreign products and savings for Americans.
Those features and the Federal Reserve's historical anti-inflationary monetary policy stance support the highest credit rating of U.S. treasury securities and investor confidence in the U.S. economy.
If the U.S. government misses interest payments on public debt soon after Aug. 2, rating agencies will downgrade U.S. treasuries, prompting investors to dump those securities and sell dollars en masse.
Such a market reaction would increase U.S. and world interest rates, decimate investment spending and trigger an inflationary spiral as the Fed is forced to monetize U.S. debt.
But given the high likelihood of such an adverse market reaction to a debt default, would the Obama administration fail to make debt-service payments a top priority after Aug. 2?
After all, debt service constitutes only 12% of incoming federal revenues — more than sufficient to cover interest payments for months after Aug. 2.
If the administration fails to service treasury debt on Aug. 2, it would transparently constitute a premeditated and deliberate policy to hurt the U.S. economy — which would irrevocably damage the president's re-election prospects.
This means, in turn, that markets are unlikely to view the risk of a technical U.S. default on Aug. 2 and of financial Armageddon soon after Aug. 2 as high. It also means a downgrade of U.S. debt is unlikely unless the deadlock continues well beyond Aug. 2.
Investor expectations that the president and Congress will soon settle on a prudent policy course, relax the debt limit and restore the government's longstanding "full faith and credit" are also likely to be sustained through and beyond Aug. 2.
Thus, few holders of U.S. government securities are likely to alter their holdings anytime soon. This expectation is validated by continued low interest rates and spreads between long and short maturity treasury securities and those between U.S. and foreign sovereign debt securities.
Make no mistake: If no budget deal is achieved for several weeks beyond Aug. 2, markets will react adversely as government spending cuts increase the chances of another recession and renewed debt monetization by the Federal Reserve. Indeed, such a reaction may be necessary to compel U.S. political leaders into a budget compromise.
But that day of reckoning seems unlikely to occur on or soon after Aug. 2. If markets are calm then, current dire prognostications of financial Armageddon by administration officials will be revealed as the overused cries of "wolf" that they are.