President Biden can end the debt ceiling. But can he handle the bond market?
So it’s come to this: another debt ceiling crisis.
This is the fifth standoff I’ve covered as a reporter. There was the big one in 2011, of course, but then the 2013 standoff related to Obamacare, the lower-profile standoff in 2015, and the 2021 fight that required a temporary change to the Senate filibuster. I’m 32 years old. As I tell myself in the mirror every morning, that is not old. And I’m on my fifth debt ceiling crisis. All of this has happened before, and it will all happen again.
The first-best solution to the standoff between President Joe Biden and the new Republican majority in the House would be for the latter to simply relent and pass legislation repealing the debt ceiling, or at least raising it without strings attached. House Speaker Kevin McCarthy is clear he won’t do that; he got his speakership specifically by promising the least responsible members of his caucus that he’d hold the debt ceiling hostage. But past speakers in his position, notably John Boehner in 2013, have blinked and wound up passing a “clean” debt ceiling bill anyway. Hopefully he does the same.
The absolute worst solution to the standoff would be for the federal government to default: to stop paying interest on its loans, or paying for programs from Social Security to the military, sending the economy into recession and the world into a financial crisis.
Somewhere in the middle are the two likeliest outcomes. One is for Biden to, like President Barack Obama in 2011, come to the table and cut a deal with McCarthy for a debt ceiling hike in exchange for spending cuts. This would avoid a recession but likely involve cuts to important programs from education to health research, which could have major negative long-term repercussions.
The final option is for Biden to use executive action to render the debt ceiling moot. There are several ways for him to do this, which I ran through in this piece. The funniest involves minting a platinum coin worth hundreds of billions or trillions of dollars. The most boring involves issuing a novel kind of debt to fund the government. Somewhere in the middle are the options to invoke the 14th Amendment and claim the debt ceiling is unconstitutional, or to claim that obeying Congress’s previously passed spending and tax legislation forces the president to ignore the debt ceiling, which some experts consider the least unconstitutional option.
Debates about these options often devolve into discussions of legal arcana and political perceptions: would it look bad for Biden to seize more power like this? Would it seem silly to mint a trillion-dollar coin? And while the legal details and the politics matter, I think much of the discussion of these options gives short shrift to their biggest challenge: the bond market.
The bond market challenge for the debt ceiling
“I used to think if there was reincarnation, I wanted to come back as the president or the pope or a .400 baseball hitter,” the political consultant James Carville once quipped. “But now I want to come back as the bond market. You can intimidate everybody.”
Bond traders obviously love that quote, but it’s not just gas for their egos. Modern governments rely on international bond markets to finance themselves, and while those governments’ control over their currencies gives them some protection from the vicissitudes of the markets, this power is hardly absolute. History is littered with cases of governments forced to abandon policies because of bond market revolts. Just a few months ago, a mass selloff by currency and bond traders forced the Tory government in the UK to abandon its plans for a massive deficit-ballooning tax cut and axe Chancellor of the Exchequer Kwame Kwarteng, before Prime Minister Liz Truss herself was forced to resign after just 45 days in office. Banks like Citigroup were openly declaring that unless the UK got a different prime minister, the markets would continue to punish it.
We know how bond markets respond to routine increases in the debt ceiling that are not attached to any other policies: they don’t at all. At first glance, the debate around the October and December 2021 debt ceiling increases, which were contested but not in much doubt given Democratic control of Congress, didn’t cause any major changes to the interest investors demanded on short, medium, and long-run Treasury bonds. Yields on those bonds didn’t spike as that debate progressed.
We also know how bond markets respond to actually dangerous debt ceiling standoffs, even if they ultimately result in the ceiling being increased. The Government Accountability Office estimated that the 2011 fight, which came really close to disaster, raised interest rates by enough to cost the Treasury $1.3 billion in 2011. That’s not nothing, but it’s pretty tiny in the scheme of the federal budget. By far the largest costs of that showdown were the budget cuts enacted in the deal Boehner and Obama cut.
What we don’t know is how the bond markets will respond to Biden making the debt ceiling history, whether through a platinum coin, or invoking the 14th Amendment, or some other means. I certainly don’t know, but people far more expert than me don’t know either. “I would stick with the answer, ‘I don’t know,’” Shai Akabas, director of economic policy at the Bipartisan Policy Center and an expert on the debt ceiling, told me. Unpredictable market reaction, he said, “has been my biggest concern about all these approaches, not that the substance would create some major economic disruption itself.”
David Kamin, an NYU law professor and former senior economic adviser to Biden, has said the same: if Biden declares he’s ignoring the debt ceiling, “Republicans will surely scream that he is acting illegally and that the debt issued over the limit is invalid. … it’s imaginable that the market could react badly — and shoot up interest rates on Treasuries.” Minting the coin could have the same result. Kamin isn’t saying this will happen: just that we’re in truly uncharted territory and it might happen.
If that just means the inflation-adjusted interest on five-year Treasury bonds goes from, say, 1.42 percent to 1.75 percent (to use the GAO’s higher-end estimate of what happened in 2011) … honestly, that seems fine. It’s not great but it would be a small price to pay for ending the debt ceiling.
But the freakout would be longer than in 2011. The matter would go to the courts. Some lower courts would likely rule against the Biden administration, which would spook markets more. The Supreme Court might ultimately rule against the administration, suggesting that its bond payments since it declared it would ignore the debt ceiling were illegal. That could push interest rates really, really high, as investors realize some of the bonds they own might have been illegally issued and perhaps not pay out.
And not just on government debt! Economist Filippo Gori has looked at how the 2011 crisis affected the cost of loans not just for the government, but for banks. He found that about half of the increased borrowing costs were passed along to banks. And if bank interest rates rise, then everyone’s interest rates rise. Other businesses borrow their money from banks, and banks will only lend them money if it’s profitable, which means the banks have to charge more than they themselves paid to borrow the money they’re lending out. So all of a sudden everyone’s interest rates are increasing. The Federal Reserve sometimes increases interest rates (as it has in recent months) specifically in order to get people to spend less money and slow down the economy. A debt ceiling crisis could have a similar effect, and potentially a bigger one. It’s easy to imagine this resulting in a full-scale recession.
This is not a problem unique to ideas like the 14th Amendment option or minting the coin. If the US were to hit the debt ceiling and the Treasury chose (as it was prepared to in the Obama years) to “prioritize” payments, paying interest on debt and a few select government programs but otherwise skipping out on trillions in government bills, bond markets would almost certainly go nuts. If the Treasury stopped paying interest on debt, and defaulted, that would be as bad or worse. Compared to those options, basically anything from minting the coin to issuing new kinds of debt is far, far preferable.
I also think these are risks worth taking relative to the option of making spending concessions to House Republicans. The trillion-plus dollars of spending cuts enacted in 2011 were harmful. They hurt millions of real people deeply. They undermined our ability to prepare for pandemics, right before we experienced the worst pandemic in a century. Worst of all, they taught congressional Republicans that they could take the debt ceiling hostage and extract big concessions, a lesson they are taking to heart now. The only way to break that precedent and prevent the ceiling from being used as a hostage for decades to come is for the debt ceiling to end — by legislation if possible, by fiat if necessary. You have to shoot the hostage.
But I think it behooves supporters of these options, like myself, to think more seriously about how to answer the challenge of the bond market. I can imagine Biden and his advisers making a choice between a deal with McCarthy and something like minting the coin, and defaulting to the former because there’s less bond market risk, and thus less risk of crisis and recession, involved. I think they’d be wrong, but it really is true that making a spending deal would have more predictable consequences in this regard. The 2011 deal did considerable harm but did not result in a recession, which would have been even worse.
Convincing the administration to take another path requires figuring out some way to reassure markets in the aftermath of Biden nullifying the debt ceiling, and to prevent the legal risk inherent in that measure from wreaking economic calamity. I don’t know how to do that myself; if I did, I’d say something. But luckily there are many people who know these markets better than I do who are hopefully working on ways to make this option more attractive to the administration. If Biden isn’t persuaded, we could be in for another decade of spending retrenchment and a lifetime of debt ceiling crises to come.