The ‘debt limit’ Kobayashi Maru

Other countries don’t do this. Businesses and households don’t do this. Other countries and businesses and households don’t do this because it doesn’t make sense.

As per the U.S. Constitution, Congress passes budgets that set the levels of spending and revenue for the federal government. The executive branch (ultimately, the president) is legally bound to follow those mandates from Congress. So what happens when Congress mandates more spending than can be paid for with the revenue it instructs the government to collect? Well, the government borrows money in order to comply with the legally, constitutionally mandated spending determined by Congress.

But here in America we add another factor — a contradictory, nonsensical, arbitrary factor that periodically threatens to destroy our whole economy. We also have a congressionally mandated “debt limit” or “debt ceiling.”

That creates the Kobayashi Maru flusterclump idiocy we’re in now:

1. The government is legally, constitutionally mandated to spend what Congress ordered it to spend.

2. The government is legally, constitutionally forbidden to collect enough revenue to pay for this legally, constitutionally mandated spending.

And, thanks to the bonkers idea of a legal “debt ceiling”:

3. The government is legally, constitutionally forbidden to borrow any more money.

If you’re not a Star Trek fan, let me explain that the Kobayashi Maru is a fictional training exercise for Starfleet Academy officers. It’s a no-win situation — a scenario in which there is no right action, no way to succeed. Whatever you do in the Kobayashi Maru will be wrong.

That’s what the debt ceiling creates for America. It means, no matter what, some law must be broken. If Congress does not increase — or, better yet, abolish — the debt ceiling, then either the government will break the law by borrowing money it is forbidden to borrow or else the government will break the law by not spending money it is constitutionally mandated to spend. Either way, Congress is demanding that the executive branch break the law.

My take on this is that the debt-ceiling law is itself therefore unconstitutional. It interferes with the constitutional responsibilities laid out for Congress and for the executive branch. Those responsibilities trump the lesser claim of reckless “debt limit” legislation that’s less than a century old. Thus if the executive branch – i.e., President Obama — is faced with the Kobayashi Maru of having to choose which law to break, it should break that law and force it to be defended in court.

That’s what Henry (“Not That One”) Aaron argues today in The New York Times,Obama Should Ignore the Debt Ceiling“:

Failure to raise the debt will force the president to break a law — the only question is which one.

The Constitution requires the president to spend what Congress has instructed him to spend, to raise only those taxes Congress has authorized him to impose and to borrow no more than Congress authorizes.

If President Obama spends what the law orders him to spend and collects the taxes Congress has authorized him to collect, then he must borrow more than Congress has authorized him to borrow. If the debt ceiling is not raised, he will have to violate one of these constitutional imperatives. Which should he choose?

… If the debt ceiling is not increased, the president should disregard it, and honor spending and tax legislation.

A decision to cut spending enough to avoid borrowing would instantaneously slash outlays by approximately $600 billion a year. Cutting payments to veterans, Social Security benefits and interest on the national debt by half would just about do the job. But such cuts would not only illegally betray promises to veterans, the elderly and disabled and bondholders; they would destroy the credit standing of the United States and boost borrowing costs on the nation’s $12 trillion publicly held debt.

There is no clear legal basis for deciding what programs to cut. Defense contractors, or Medicare payments to doctors? Education grants, or the F.B.I.? Endless litigation would follow. No matter how the cuts might be distributed, they would, if sustained for more than a very brief period, kill the economic recovery and cause unemployment to return quickly to double digits.

Nor is it reasonable to expect the president to collect more in taxes than is authorized by law. For him to do so would infringe on Congress’s most fundamental powers and the principles on which the nation was founded.

The only defensible option for the president if the debt ceiling is not raised is to disregard the debt ceiling.

There is, however, one other possibility. Obama could do what James T. Kirk did when facing the Kobayashi Maru: rewrite the rules.

The following suggestion may sound outlandish or impossible, but it’s not. It’s the only legal recourse — the only way for the government not to break its own laws if the debt ceiling is not abolished: Have the Treasury mint one thousand $1 billion platinum coins.

It’s legal. Every other approach, including Aaron’s, is not.

Is it kind of goofy? Sure, but it’s far less goofy than the Kobayashi Maru of any of the various illegal options — all of which would entail enormous suffering on a massive scale.

I’m a big proponent of avoiding enormous suffering on a massive scale. Particularly when such suffering is unnecessary.

So mint the coins.

  • Lorehead

    We’re not borrowing from the future. We’re borrowing from bond purchasers today, most of whom are still Americans. It’s possible that this could eventually cause some problem later, but that won’t necessarily happen, it definitely is not happening now, and most people’s assumptions about what could happen and how are completely wrong.

  • Lorehead

    You seem to be asserting that for the Federal government to forgive the trillions of dollars of its own debt that it owes to itself would have some huge effect on interest rates, or Real True Inflation, or something, equivalent to a sudden contraction of the money supply by the same amount. That’s nonsense.

    Why doesn’t your same argument prove that for China to manipulate its currency by purchasing dollars with renminbi and taking them out of circulation would similarly have no effect? Doesn’t increasing or decreasing the number of dollars in circulation by exchanging them for other assets affect the purchasing power of dollars?

  • http://blog.trenchcoatsoft.com Ross

    Don’t you know, government employees just set their paychecks on fire when they receive them, prefering to sustain themselves by sucking on the teats of the giant government beast.

  • Rhubarbarian82

    My dad and I tried. That’s one of the reasons she hung up. I also suggested, that if she wanted to deal with the debt, that we raise the taxes and cut military spending. And that, if she’s concerned about the debt, then shutting down the government is a terrible idea, because it is going to cost us billions.

  • Andrew G.

    How did you get that from what I wrote? It’s almost exactly backwards.

    Excess reserve balances force down the short term interest rate and shortage of reserves drives it up; but any dealings that the government does with “debt that it owes to itself” cannot influence reserve balances since it is purely an accounting manipulation that does not involve any non-government party.

    And my argument says nothing about what would happen if China purchased dollars because I was addressing the issue of government spending, and there is a qualitative difference between a government spending its own currency and it dealing in other currencies.

  • Andrew G.

    In fact, if the US tried to “pay” its national “debt” by increasing taxation, the economy would collapse long before it got very far.

    The “Clinton surpluses” proved that; those surpluses were not caused by good management of the economy, but by runaway private sector deficits (i.e. private sector investment borrowing outstripping private sector savings) which for a while exceeded the import surplus. (The government balance is exactly equal to the difference between these figures.) Since the private sector (unlike the government) can’t run a deficit indefinitely, it is clear that a government budget surplus is a bad sign unless it is the result of an export surplus (of more than about 3-4% of GDP, because the stable state of the private sector balance tends to be a surplus of about that much).

    The debt-to-GDP ratio means essentially nothing (though the amount of interest payments is important – but the government can choose to keep interest rates low). The credit rating means nothing either – the government isn’t beholden to credit ratings unless it chooses to be, not even when it comes to setting interest rates.

  • Andrew G.

    In a fiat-currency system, the government can no more have, or not have, its own money than you can have IOUs made out to yourself. Money in the government’s own hands in a very fundamental way ceases to exist; it comes into existence when the government spends it into the economy, and vanishes again when the government takes it back.

    So why have taxes then, if the government has no limits on spending? Because if the government bids against the private sector for scarce resources – real resources, not financial ones – then it will drive up prices and you get inflation. (Even in fiat-currency economics there are no entirely free lunches.)

    But government spending isn’t necessarily automatically inflationary. If there’s some resource just lying around unused, and the government decides to buy some of it (at whatever price is offered), then there’s no reason for that to increase the price of anything. And if that resource happens to be the labour of otherwise unemployed people, then everybody wins.

    The mindset of thinking that taxes pays for government spending – rather than taxes making it possible for government to spend without excess inflation – makes you vulnerable to the error of thinking that some government action isn’t possible because the country can’t afford it, rather than it being impossible due to purely political concerns. Money should never be allowed to be a limiting factor; what matters is the availability of real resources.

  • Lorehead

    In my example, the Chinese government, which was a government, was spending its own currency! Please at least keep your metaphysics straight. I don’t think this discussion is going to be very productive, and it’s definitely turning into a threadjack.

    To back off a bit, let me make a different argument. Compare scenario A and scenario B:

    Scenario A:

    1: The Treasury creates $1T worth of bonds.
    2. The Treasury sells treasury bonds worth $1T to the public.
    3. The Treasury deposits $1T in its bank account.

    Scenario B:
    1. The Treasury creates a platinum coin with face value of $1T.
    2. The Treasury deposits this coin in its bank account.
    3. The Federal Reserve returns the coin to the Treasury, which destroys it.
    4. The Federal Reserve sells treasury bonds from its portfolio worth $1T on the open market.
    5. The Federal Reserve deletes the $1T it received from the bond sales from its account.

    In either case, the end result is exactly the same: the public ends up with $1T worth of treasury bonds, the Treasury ends up with $1T in its bank account, and the number of dollars in existence is the same as before. Therefore, these two scenarios are practically equivalent.

  • Lorehead

    Wow, remember how I just posted how Clinton’s enemies used to argue that surpluses are bad? Alan Greenspan’s arguments were smarter than this, but what a nostalgia trip!

    Consider, to take just one problem here, that all global trade balances, and therefore the trade surpluses and deficits of all the countries in the world add to zero. That implies under your theory that there always must be net importers, who should be running a budget deficit, which will directly create private-sector growth, and since surpluses and deficits should be proportionate to the balance of trade, and shoudn’t even begin until the trade surplus is substantial, that the total amount of government debt in the world must and should always increase! The only alternative would be to “export” a large amount of goods to a nonexistent customer, for example by dumping them into the ocean and having a stateless central bank pay for them, or offshoring tech support for nobody. This busy-work would let everyone run a trade surplus and therefore a budget surplus. It’s like hyperkeynesianism.

    Otherwise, another economic nightmare like the ’90s might ensue, and aren’t we all glad that’s over?

  • Andrew G.

    What’s the point of your scenario B? It bears no resemblance whatsoever to any actual proposal.

  • Lorehead

    Scenario B is the platinum-coin plan with sterilization. Scenario A is a bond auction.

  • Andrew G.

    It is in fact true that if there were a single world government (and hence no external trade), then it would run a budget deficit for the forseeable future; it would likely only balance its budget if both population and (maybe) productivity became stable.

    This is based on the simple observed fact that people do, given the chance, save some of their money in the form of financial assets. As long as net saving continues, the government is getting less money back in tax revenue than it spends; in fact, the accumulated budget deficit (the “public debt”) is exactly equal to the total private savings.

  • Lorehead

    That is nonsense, and I’m not continuing this any further.

  • Andrew G.

    Then the only difference, unless I’m misreading you, is that scenario A is subject to the debt limit and scenario B is not (assuming that the Fed has $1T in bonds on hand).

    (Wouldn’t the Fed have to retain the coin as an asset, though?)

    As I understand your original argument, though, your position is that the bond sale in scenario B is an essential component of the process, whereas my position is that it is not. So you think it would work only as a one-off stopgap (or at best a limited number of times), while I maintain that this restriction is based on no evidence.

  • http://apocalypsereview.wordpress.com/ Invisible Neutrino

    It can be considered “borrowing from the future” in the sense that borrowing allows you to shift today’s spending into a time ahead of the present (that is, you can have what you’d like to have now, but you must pay for it down the road), but economic growth generally ensures that there will always be more money later to pay for what’s been run up on the books today. And when not paying for things like wars but instead on roads or schools, such borrowing is rather sensible as a way to build the asset base of the nation for the time when the bonds hit maturity.

  • Lorehead

    I don’t believe that it would need to retain the coin any more than it needs to retain a quarter you deposit, but I could be wrong.

    If you don’t do steps 4 and 5, the number of dollars in circulation, once the Treasury spends them, increases by 1T, while the value of bonds in circulation does not change. (Alternatively, the Treasury could just sell the coin to the Federal Reserve and use the money to purchase bonds from the Federal Reserve, then auction the bonds it bought while the dollars never leave the Federal Reserve. Same effect as just creating the bonds out of thin air instead of the coin.) You don’t have to destroy the trillion dollars you just created, but if you don’t, they will be inflationary.

  • Lorehead

    It is important to realize that today’s spending will be matched, later, by payments to bondholders. These payments will not disappear into the past through a time machine, nor are they coming from a time machine, and most will stay inside the country. That’s why it makes sense to worry about crowding-out.

    If you’re actually fighting Hitler, money is no object in the literal sense: if the Luftwaffe bombed your printing presses and you ran out of currency, you would not let that stop you from building planes and tanks or putting men in them. Most other wars, though, have been somewhat more dubious in value.

    Governments can in fact do any kind of investment the private sector can (and China’s still does), although this is not usually a good idea. Or, what was the return on investment for the Louisiana Purchase? It’s completely mistaken to moralize the national debt, since the government’s moral responsibility is not to avoid issuing bonds but to promote the general welfare. Sometimes, that means spending more money than you tax.

  • Andrew G.

    The hidden assumption there is that the “created” trillion dollars is automatically inflationary but that auctioning a trillion dollars in new bonds (scenario A) and spending the proceeds is automatically not inflationary (or is less so, or differently so). Likely underlying this assumption is another one, which is that base money and broad money are linked by a multiplier.

    This is the part I referred to as “articles of faith”, and lacking in evidence.

  • Lorehead

    At a very basic level, there is a supply and a demand for dollars and a supply and a demand for treasury bonds. It therefore makes a huge difference to the value of both whether you create a trillion dollars or a trillion dollars’ worth of treasury bonds.

    If creating dollars to pay the bills were not inflationary, we should be doing that rather than taxation.

  • Andrew G.

    If they were independent assets that might be the case – but in practice they are closely linked by the desire to maintain a target interest rate. Also, since this is base money we’re talking about, not broad money, the level of supply and demand for it will likely not be visible outside the banking sector.

  • Andrew G.

    If creating dollars to pay the bills were not inflationary, we should be doing that rather than taxation.

    Again, exactly backwards; see my response to EllieMurasaki.

  • Lorehead

    Well, good luck trying to convince every mainstream economist on Earth that the ’90s were a disaster that we must never repeat.

  • Lorehead

    Oh, and as for the second part, auctioning the bonds off is an exchange of money from the public for bonds from the Treasury. Whether that affects the price level or not depends on what the purchasers of the bonds would have done with the money.

    Two examples: if the government sells bonds to fund a project, and the purchasers would otherwise have invested the same amount of money in the private sector to fund the exact same project, then it made no difference in the short term and the inflationary effect is zero.

    If, on the other hand, the purchasers would otherwise have hid their money under the mattress and never spent it, the inflationary effect is exactly the same as if the Treasury had printed the money.

  • Andrew G.

    You think bubbles are good?

  • Lorehead

    If the price for the dot-com bubble was the mild recession at the start of this century, then it was more than worth it. The housing bubble, remember, took off while we were running a large deficit.

  • Andrew G.

    And, of course, the first of your examples is vanishingly rare (since the main reason we have governments is to do stuff that otherwise wouldn’t happen), and the second one is overwhelmingly common (people don’t, outside of wartime, buy government bonds to fund the government, but rather to have a highly secure mattress to put their cash under), that suggests that in practice, we should find no difference in inflationary effects between deficit spending backed by bonds and deficit spending not backed by bonds.

    (Though in the no-bonds case, people may have to find alternative mattresses)

  • Lorehead

    On the other hand, commercial bonds or bank accounts are common alternatives to government bonds, and those funds will be invested in something. Probably not, as you say, the same kind of thing as the government is doing. But the government does a lot of different things with borrowed money, from cutting taxes (effectively a transfer payment from bondholders to taxpayers, to be repaid later) to food stamps (almost all of which will be spent and none saved) to basic scientific research and infrastructure (very much investments).

  • Andrew G.

    It’s not clear that the two events can be separated. In fact if you look at the graphs (there was an excellent one in the FT a couple of years back, let me see if I can attach it here), the private sector balance barely got back into surplus in ~03 before going back into deficit. The public sector was in deficit at that time (unlike the late 90s) because imports had increased (remember that the government deficit is exactly the difference between the private and external balances).

    Image credit, if this works: Gavyn Davis, FT.com, published in late 2010 (iirc) titled “Most important graph of the year”

  • Lorehead

    It’s true that, if you count every transaction between the public sector, domestic private sector, and foreign sector, or any division of the economy into any arbitrary sectors, as changing the “sectoral financial balances” in equal and opposite amounts, these will add up to zero, but that identity by itself really does not tell you much about whether it is wise or unwise to run a deficit. Norway and Singapore come to mind as examples of governments that run large persistent surpluses and invest them abroad. Alaska runs a large export surplus, but pays it out to its citizens as a dividend. How does the fact that the public sector financial balance from one is positive and the other negative meaningfully help evaluate either policy alternative?

  • Andrew G.

    I think you missed the point – the US surpluses weren’t bad because they were surpluses, they were bad because they were the result of large private-sector deficits.

    Norway runs a government surplus because it is a major exporter. That situation is stable (whether optimal or not) as long as the export business holds out. My point was that the US could not run a government surplus in a stable and sustainable manner without a major change to its balance of trade position (in which its status as a reserve currency does not help); and if it tried to do so by taxation, it would (a) fail and (b) cripple its economy in the process.

  • Lorehead

    But Singapore? I don’t fully trust my ability to come up with a good example at this hour of the morning, but I can immediately think of other stories to tell about that graph. Couldn’t the growth of the BRICs and thus the foreign sector have been the driving factor that would have happened anyway, in which case the Clinton administration was right to think that it was necessary to reduce the deficit in order not to crowd out private-sector investment? Wouldn’t it be possible, at least in theory, for a country to run persistent public-sector surpluses and private-sector deficits, punctuated by bailouts to help deleverage the private sector when that created problems?

  • EllieMurasaki

    In a fiat-currency system, the government can no more have, or not have, its own money than you can have IOUs made out to yourself.

    I have a check made out to myself for ten dollars. I grant you that the purpose of the check is to reduce my available checking balance per GnuCash by ten dollars so I don’t overdraw my available checking balance per credit union if my expenses for the pay period exceed my paycheck, not to give me any more or less money. And it’s a check that will never be cashed unless I change financial institutions. But the check exists.

    Money in the government’s own hands in a very fundamental way ceases to exist; it comes into existence when the government spends it into the economy, and vanishes again when the government takes it back.

    This still doesn’t make sense.

    The mindset of thinking that taxes pays for government spending – rather than taxes making it possible for government to spend without excess inflation – makes you vulnerable to the error of thinking that some government action isn’t possible because the country can’t *afford* it, rather than it being impossible due to purely political concerns. Money should never be allowed to be a limiting factor; what matters is the availability of real resources.

    Okay, this makes sense, I agree—-oh. You’re talking explicitly and only about the federal government. I work for the state government, which is limited by the tax receipts.

  • http://blog.trenchcoatsoft.com Ross

    Total private savings plus trade deficit.

  • http://blog.trenchcoatsoft.com Ross

    Try convincing them that the housing bubble was a bad idea.

  • Andrew G.

    I’m not quite sure how a OWG is supposed to have a trade deficit…

  • Andrew G.

    Singapore is also a major exporter – it runs a current account surplus of about 20% of GDP, and a government surplus of about 2%, leaving a private sector surplus of 18%.

    You seem to be thinking (it’s a common mistake) that the government directly sets the size of the deficit; in fact, it’s the aggregate decisions of the private and external sectors that define the deficit. The government’s decisions on spending and tax rates affect the deficit only to the extent that they change private sector behaviour; if the private sector “decides” that running a private-sector deficit greater than the external deficit is a good idea, then the government balance will go into surplus automatically. If the government increases spending to try and avoid that, it only succeeds to the extent that its increased spending results in less private borrowing.

    If a country did try to run a cyclic bubble/bailout pattern – which is quite possible if the private sector is prepared to go along with it, which would likely require little more than certain types of bailout guarantees from the government – then all that happens is that the surpluses from bubble years are wiped out by the massive deficit needed for the bailout. The long-term position would be that everything still balances, with the long-term government deficit equal to the difference between the long-term private sector balance (which in this scenario will depend mainly on how much the private sector wants to net save on a long-term, multi-cycle basis) and the export surplus.

    Of course this would have problems other than the purely economic ones; if the bailout money went largely to the financial sector, then the effect would be a large-scale transfer of wealth on each cycle from the productive economy into the financial sector, which couldn’t be sustained indefinitely.

  • Lorehead

    This has turned into a threadjack, so I’ll just say that I really think you’re severely misinterpreting an accounting identity.

  • Consumer Unit 5012

    Remember when a balanced budget was against Republican principles? It was just last decade.

    It’ll be against their principles again the instant a Republican becomes president.

  • hf

    So while minting coins works, if that’s the new rule we make, we’ll be forced to use it over.

    No we won’t, because the terrorists threatening not to raise the debt ceiling will realize it profits them nothing.


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