A crisis of government leads to widespread calls for massive budget cuts. Pressure coming from the rating agencies lead to a loss of confidence in the stability of the national debt. It was only a matter of time in fact before our country’s bonds turned into complete junk. Something had to be done. More importantly, something had to be done to balance the budget. In the name of saving the nation, cuts had to be made.
This story has in fact twice in recent North American history. More to the point, recent Canadian history has shown this to be a manifestation of economic destruction executed via shock political tactics. Nevertheless, the story has repeated itself south of the border in the US.
2011 - The US Debt Ceiling Crisis
In 2011, as national debt figures reached 100% of the country’s GDP. This was ostensibly due to the huge expenses borne by both the Bush and Obama administrations in relation to the eruption of the 2008 financial crisis. The fact of the matter is that while US debt/GDP levels have reached recent high-water marks, they are in fact comparable to those of the US in the 1950’s, a time of widespread economic expansion in US history.
Evolution of US indebtedness
How could such a scare therefore have been stirred up about the budgetary stability of the world’s largest economy in a matter of weeks? What actually happened?
Earlier the same year, in January of 2011, the newly elected republican House repealed the Gephardt rule. One of the key clauses of this rule was the automatic debt-ceiling rule. Under the Gephardt rule: “joint resolution specifying the amount of the debt limit contained in the budget resolution automatically is deemed to have passed the House by the same vote as the conference report on the budget resolution”
In other words, the US fiscal budgetary credit limits were an internal part of the budgetary debate and not a separate item. With this provision gone, conservative forces were free to fabricate a national sovereign credit crisis where none had existed before. Indeed, the statutory debt limit was used as justification to strictly limit the US Federal Government’s credit facilities if no action was taken by August 2nd 2011. In other words, if nothing was done, the US would run out of credit because it would hit a debt ceiling, which had been wholly fabricated just a few months before. The Letter from Tim Geithner to Harry Ried outlines the ultimatum:
What followed was the Budget Control Act of 2011, which stipulated $917 billion of cuts over 10 years in exchange for a $900 Billion increase in the US debt limit. $21 Billion in budget cuts were slated for the fiscal year 2012. A debt adjustment which was hitherto mechanical was turned into a matter of crisis and political shock tactics to try to force cuts in public services and jobs in the middle of a recession and economic crisis period. On August 5, 2011, the US was downgraded by the rating agency Standard & Poor's. This led the Dow to lose 6.5% of its value the following day.
The real answer to the question of what actually happened takes a page out of the Canadian strategy book and brings it into play on the US side of the border.
1993- The Canadian Debt Wall
In February 1993, Canadian press began running stories about the impending exhaustion of Canadian sovereign credit borrowing capability. Apparently, the country’s credit was about to run out and Canadian sovereign debt was on the brink of being downgraded dramatically, casing a massive pullout of investor funds from the both Canadian bonds and Canadian economy at large. The only apparent solution was to massive cuts in Canada’s democratically popular healthcare and social expenditures. The Canadian Liberal party ultimately did just that.
Two years after the fact, Vincent Truglia, the senior analyst at Moody’s in charge of issuing Canada’s credit rating, divulged to the media that had come under constant pressure from Canadian corporate executives and bankers to issue damning reports about the country’s finances. Because he considered Canada an excellent, stable investment, he refused to do so. In other words, Truglia was being pressured to corroborate the view that Canadian debt was way too high and some massive cute had better be made.
The Gephardt Rule
The Gephardt Rule is outlined in this Wikileaks document. While it is actually a 2003 change in the House Rules for the Congressional Budgetary Process, by which time the Gephardt Rule already existed, this document represents the most recent working version of the rule.
While this is not the first time that the House has done away with the Gephardt Rule, it is the most recent.
About the Author:
Max Berre is an economist who has worked as a sovereign debt expert at the Inter-American Development Bank in Washington and has taught financial economics at Maastricht University in the Netherlands.