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A Winning Strategy on the Debt Ceiling (Courtesy of Warren Buffett)

Thursday, February 7, 2013

Gauge our ‘ability to handle’ the debt by considering it in relation to the size of the economy.

Now that the Republicans have postponed the debt-ceiling debate, they’ve bought themselves some valuable time. If they use it wisely, they’ll discover a new strategy for handling the federal debt — a strategy that’s not just better for their party, but also better for the whole country.

Warren Buffett, in a recent interview on the CBS “Sunday Morning” show, revealed the kernel of an idea for what could be a new basis for managing the debt ceiling. The policy would spring from a basic principle: when a game isn’t winnable, one should change the rules. The political game of threatening not to raise the debt limit is unwinnable — whether it’s played by Republicans or Democrats. So it’s time to change the rules.

The debt ceiling law as it stands today places a fixed-dollar limit on the level of federal debt. It originated a century ago as a reasonable limit on borrowing for specific (micro) programs, but gradually morphed into an absurd limit on the entire (macro) budget. For decades it has been a self-imposed financial weapon of mass destruction, and its only effect so far has been to enable political opponents of the party holding the White House to grandstand for the cameras.

The fixed-dollar debt ceiling, as Buffett implies, is single-entry accounting that fails to place debt in context; it ignores our ability (or inability) to handle a given level of debt. Senator Tom Coburn echoed the same theme two days after Buffett: maintaining the world’s confidence in our “ability to handle” our debt is all-important.

But how can we gauge our ability to manage our federal debt, when the only number we pay attention to is the debt number by itself? We can’t — but the House Republicans are in a position to fix that problem by following Buffet’s cue.

As is typical for Buffett, his remedy is simple and elegant: we should gauge our “ability to handle” the debt by considering it in relation to the size of the economy; i.e., by paying attention to the debt-to-GDP ratio. My article “What Does ‘Fiscal Responsibility’ Mean?” listed four possible definitions for that nebulous phrase. In essence, Buffett favors definition (c) for “fiscal responsibility”: the debt-to-GDP ratio is on target and sustainable.

Three Steps to a Potential New Strategy for the Debt Limit

In the several months before the debt limit issue resurfaces, the House has an opportunity to change the rules of the game for the better.

Step one: Surprise everyone. Propose abolishing the current debt limit law for good — thereby abolishing the periodic grandstanding by Democrats when a Republican occupies the White House and by Republicans when a Democrat is president. Although this would be a blow to politicians in general, it would be a boon to public discourse. It would be good riddance, at last, to what is, at best, an absurd waste of everyone’s time.

 

Step two: In place of the current law, propose one that institutionalizes what Buffett has called our “debt capacity,” defined as a maximum “safe” level for the debt-to-GDP ratio. Settling on the maximum level that Congress agrees is “safe” will be painfully difficult, but also highly educational. About all anyone knows today is what Buffett said: the debt ratio is lower today than it was after World War II, but we need to stop it from increasing. That’s not enough; we need to improve this situation by settling on a specific number or range — say, 120 percent (total federal debt compared to GDP), the high-water mark after World War II. The debate to settle on a number would reveal a great deal about opposing ideas for enhancing economic growth and would force a healthy debate as to how to stabilize or improve our debt capacity. One way to do that, of course, is to slow the growth of the debt — but another way is to speed up the growth of the economy.

 

Forcing Congress to commit to a “maximum safe” debt-to-GDP ratio would force Congress to bring growth into the debate. Faster economic growth softens (or completely offsets) the effect of growing debt. (Grammar school arithmetic, for example, reveals that the ratio of debt to GDP can shrink, even if debt grows.) Growth would become a primary topic in congressional debates.

 

Step three: Require an annual report by the Treasury Department titled “U.S. Debt Capacity: Status and Outlook.” Such a report would not only sharpen the annual budget debates, it would give the world bond markets an official benchmark for assessing the quality of U.S. Treasury securities — ideally shoring up the market’s confidence in America’s economic future.

In short, a new strategy for handling the federal debt would introduce the size and growth of our economy into the equation. A “maximum safe debt capacity” of, say, 120 percent GDP would cleanse political grandstanding from the debt limit debate. More importantly, it would introduce economic growth into the debate — a third way, besides tax-rate hikes or spending cuts, to ease the debt burden.

Growth: Democrats vs. Reagan Republicans vs. the Tea Party

Maintaining the world’s confidence in our ‘ability to handle’ our debt is all-important.

Democrats, mostly Keynesians, lean strongly toward the top-down, government-knows-best approach. Growth “just happens” (it’s exogenous). In economic slumps, trust the government to end the slump by stimulating the economy back to full-employment production of familiar goods and services. Trust it to reduce the likelihood of future such slumps by tightening its regulations and oversight of those it perceived to be the cause of the last slump. Trust it to choose and to subsidize the “correct” new technologies. Trust it to constrain the greed of established private-sector businesses through steadfast regulation, taxation, and punishments meted out by government’s expert regulators. Trust it to punish all of “the rich” — identifiable by the adjusted gross income line on their tax returns — instead of doing the hard work of singling out and punishing only the predators, pirates, and parasites. (How well that’s working out for us is the subject of a new PBS series, by the way.)

On the other hand, the Republicans are a mixed, frequently contradictory bunch. Some — specifically those in the Tea Party — have apparently forgotten the difference growth and innovation can make, let alone what drives such growth, because their only visible passion is a singular focus on “cut, cut, cut.” To this faction, a dollar spent by government (on anything) is the same thing as a dollar set aflame; the federal debt must somehow, someday be “paid off” instead of continually rolled over; “investment” by government is just a code word for more wasteful spending; and “small government” means government that only costs a small amount of money.

Other Republicans subscribe to Reagan’s approach. “Small government” means government that has only a small list of duties. Real growth is driven by organic private-sector producers supported (not hindered) by government. The government enables endogenous (“from within”) private-sector growth; trusts entrepreneurs and producers to innovate new, previously unheard-of technologies, products, and services that nobody could predict beforehand; and inhibits economic predators and parasites. Broadly shared wealth emerges from innovation, which in turn emerges from the frequently chaotic process of trial-and-error in a competitive business environment mostly free from the supervision and “benevolence” of government experts who allocate capital and favors as they see fit. Protecting the private sector’s organic, trial-and-error process requires the government to “invest,” in order to provide public goods such as national security and new knowledge derived from exploration and basic research.

At this point, it’s anybody’s guess which of those two factions will win control of the Republicans’ agenda; but if the Reagan legacy prevails, the Republicans can strategically shift the debate toward economic growth — a debate they have the ability to win on the sheer force of historical evidence.

Three Possible Outcomes for the GOP; Two of Them Bad

The debt limit issue will resurface in May. There are three possible outcomes for the Republicans:

1. Worst case: the Republicans refuse to raise the debt limit; the president orders the Treasury to sell new Treasury debt anyway (to fund mandated spending in excess of tax receipts); and the Supreme Court subsequently decides in favor of the president and the Fourteenth Amendment to the Constitution. Probable result: acceleration in the decline of the Republican Party.

 

2. Same old case: the Republicans raise the debt ceiling for another few months, keeping the playing field wide open for future political grandstanding around the debt limit for both parties. Probable result: no change in the rate of decline of the Republican Party.

 

3. Best case: the Republicans change the rules of the game by acting on Buffett’s hint. The “debt ceiling” is thrown out because of its absurdity and replaced by Congress’s deliberated assessment of a new stake in the ground: the “maximum safe debt capacity” expressed as a percentage of GDP. Probable result: renewal of substance in the public debate and of prospects for the Republican Party.

Which will it be? We should know by May 2013. Much depends on which Republican faction dominates their caucus in the next several months.

Steve Conover retired recently from a 35-year career in corporate America. He has a BS in engineering, an MBA in finance, and a PhD in political economy.

FURTHER READING: Conover also writes “Grand Old Party Poopers,” “How to Reduce the Debt Burden for Future Generations,” and “The Tea Party and the Debt Ceiling vs. Economic Growth.” John Steele Gordon discusses “Debt and the Constitution.” Ramesh Ponnuru explains “Why a Debt Ceiling Fight Is Good for the Country.” Marc Thiessen says the “House GOP Makes the Debt Limit Magically ‘Disappear.’

Image by Dianna Ingram / Bergman Group

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