Daniel Gross

Debt Deal or Not, Confidence in America Is Shredded

When it comes to the economy, government isn't the solution, it's the problem, Ronald Reagan used to say. The news coming out of Washington over the last few days hammers home that point.

Only this time, it's not Washington conducting business as usual that's the problem. No, the problem is our government's inability to conduct the usual business of legislating, cutting deals and compromising.

I'm talking, of course, about the absurd, unnecessary, insane debt ceiling standoff. The financial crisis of 2008, which spilled over into the real economy, was essentially made in New York with a decent assist from Washington. By contrast, the current crisis of stagnant growth and potential default has been entirely manufactured in the nation's capital.

It didn't have to be this way. While deficits have been high and what doctors might dub "concerning," they didn't pose an existential threat to the economy. Despite the eternal warnings that the bond vigilantes lay just around the corner, interest rates on government bonds remained low, even after the Federal Reserve stopped buying them. Sure, the ratings agencies have been making some noise. But, seriously, we're supposed to take marching orders from the kind of guys who said "it could be structured by cows and we would rate it?"

In fact, due to concern about deficits, the government has been a drag on the economy for some time. For months, we've been writing about the concept of a conservative recovery. Each month the government sector, which is seeking to rein in spending, cuts jobs while the private sector adds them. The disappointing GDP report released on Friday noted that in the first quarter, government spending as a whole knocked 1.23 percent off the rate of growth. Government contractionary action was almost as much of a drag on growth as the large trade deficit.

Now the government is threatening to deliver a demand shock that would make September 2008 seem like a walk in the park. The government won't default on its debt. But imagine what would happen to Wal-Mart's sales if payments for food stamps were disrupted? The government currently accounts for about 45 percent of total health care spending, which means doctors, hospitals, insurance companies and drug firms would face huge reductions in business. Soldiers might get paid, but defense contractors? Meanwhile, the nonstop talk of default may already be having a contractionary impact. Anything that encourages people to put their money under a mattress rather than spend, invest or lend it acts as a brake on the economy. Raise your hand if you haven't considered getting out of money market funds in the past week.

It's tempting to place the blame squarely on those crazy House Republicans. We've reached the point where even reliable right-wing Obamaphobic columnists like Niall Ferguson and Kathleen Parker are doing it. The House took what should have been a routine transaction and turned it into a hostage drama. It's worth repeating, once again, that officials like House Majority Leader Eric Cantor voted for the Bush tax cuts, voted for all the war spending, voted to create the Medicare prescription drug benefit (with no financing mechanism) and then just a few months ago signed off on a deal to extend the Bush-era tax cuts and add a new payroll tax cut -- a move that had the effect of hastening the arrival of the debt ceiling.

But while the House Republicans may threaten to drive the fiscal car off a cliff, they had plenty of help from official Washington in assembling the vehicle. Jon Chait of the New Republic has pointed out that all the good-government, bipartisan, centrist deficit hawk institutions embraced the notion of using the debt-ceiling increase as a hammer to forge a grand bargain on revenues and spending. So did President Obama.

The notion struck many, including this observer, as fanciful. Hadn't everybody been listening to the freshmen who said they had no interest in raising the debt limit, period? More significantly, hadn't they been paying attention for the last few years? Given the current dynamics, as we've noted before, when the question is "Deal or No Deal," the answer is usually "No Deal." Since the election of 2008, Congressional Republicans have shown that are they unwilling -- for emotional, psychological or for sound tactical reasons -- to make a deal, even on initiatives they had previously supported. Anything Obama thinks is a good idea is, by definition, anathema to them. Seriously, if the president were to propose putting Ronald Reagan on Mt. Rushmore, the House GOP would reject it en masse.

Then, inspired by talk radio hotheads and Sarah Palin Facebook postings, they would quickly pass a motion to destroy the whole thing because it's expensive to maintain, pays homage to a government activist (Abraham Lincoln) and a Progressive (Theodore Roosevelt), and is really just inhibiting companies from drilling for oil and gas.

The Obama administration hasn't just been guilty of naivete. Poor planning (the debt ceiling increase should have been part of the tax cut deal), a general lack of urgency and an inability to join forces with Senate Democrats and come up with a plan they could emphatically embrace and push as an alternative have aggravated matters. Pushing aggressively on the concept of compromise is much less effective than using the bully pulpit to push for a specific one.

I still believe that the ultimate catastrophe will be averted, most likely with a small-ball deal. But it will come at a large cost -- to global confidence in America, to actual demand and to economic activity. Regulations may foment economic uncertainty, but so can threatening to blow up the entire financial system.

Daniel Gross is economics editor of Yahoo! Finance. Email him at grossdaniel11@yahoo.com, and follow him on Twitter @grossdm.

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