FRONT PAGE CONTRIBUTOR
How to Handle the Debt Ceiling
On today’s edition of Coffee and Markets, Brad Jackson is joined by Francis Cianfrocca to discuss the impending debt ceiling deadline, Mitch McConnell bowing to the Democrats, and how Francis would solve the problem.
June 20, 2011
Cianfrocca: Brad, I hope you had a very pleasant Father’s Day with her family and of course your new baby.
Jackson: Well, baby is not here yet, but yes. We went to a lunch this morning, early lunch. Then I spent some time at the cigar club with some buddies –
Jackson: — because I mean, that’s a great way to spend Father’s Day, watching NASCAR and Golf, smoking some cigars and drinking scotch. Great way to spend a Sunday.
Cianfrocca: Well, both of my children have four legs and fur and they pretty much slept the whole day away, so I didn’t get any involvement from Father’s Day. And then my wife, of course, spent the day at the beach so I was on my own for lunch again. And I wasn’t able to have hot dogs this time because we ran out of them.
Jackson: I heard the supply is short these days.
Cianfrocca: Yeah. It’s like it’s coming from some place in Brooklyn. I mean, it’s like somebody is trying to corner the market. And I hear that it’s electronic too. I mean, they’re going out through Twitter somehow.
Jackson: Yeah. I heard Al Gore is going to have a surplus of those soon.
Cianfrocca: You know something, Al Gore is somebody I do not want to talk about.
Jackson: Okay. Let’s talk about Mitch McConnell then. Of course, the Sunday shows are a wonderful staple of stupidity in Washington. And on CBS’s Face the Nation on Sunday Mitch McConnell –
Cianfrocca: Or Deface the Nation.
Jackson: Yeah. Mitch McConnell came out and essentially said that he’s broken and that there may be a short term debt ceiling hike. There’s a lot of talk about this. James Baker wrote a wonderful piece in the Wall Street Journal we’ll get to in a minute about how to deal with the debt ceiling limit. But this has become a very charged issue for Republicans.
Jackson: The Tea Party is amped about this. Conservatives are amped about it. And it seems like the grassroots think one thing and the policy makers in D.C. think another, and they are willing to bend on this like McConnell and kick the can down the road for the umpteenth time. But the folks back home are really tired about that.
Cianfrocca: Yeah. And of course you know –
Jackson: And for good reason.
Cianfrocca: — Senator McConnell who gets up and says, you know, I think we can possibly talk about extending the debt ceiling for a few more weeks and come back in the fall and have this conversation again. And you have to think, it’s not really a surprise. It is not a surprise because the consequences of failing to increase the debt ceiling on a sustained long-term basis are dire. It’s just not something you can do and that’s a matter of mathematical reality. But you’re right when you say that the people are completely fired up about this. I mean, it’s not just Tea Party adherence and political conservatives.
And of course, people in the Tea Party will make the point, if you listen to them carefully which not a lot of people in the press do, they’ll tell you a lot of people in the Tea Party are Democrats and people who have never been political a day in their lives. And they think people on the Republican side and among conservatives, especially in Washington who think that the Tea Party is, you know, if anything is a member of the right hand team, I think they are misreading it pretty drastically. And the mood among the people is, let us get spending under control.
I have a question. You know, the big question I have is do the people who feel that way, they are recognizing something intuitively which is that you can’t keep borrowing money. You know, when you don’t’ have any left and you’ve got no visible way to pay it back. I mean, that’s just a recipe for trouble. Look at what’s going on in Greece and you take that intuitive gut feeling that so many people have, you put it together with the politicians in Washington and the expert economists who are advising them, and the economists will say oh, you know what, I can think of about five different reasons off the top of my head, you know, if we had non-convertible currency. We print our own money. We issue debt on our own currency. Japan is a 200% of GDP on total debt, we’re still at 90%. Long way to go. Interest rates are incredibly low. Millions of reasons why we can keep borrowing, but the people don’t want it. And it’s one of those genuine serious populist moments that have only happened a few times in US history.
And so a big question about is, are the people going to follow through? And I think, you know, you and I have heard a little bit through the back channels, the political heat on the conservative right wing side is going to start heating up seriously to really put a lid on this.
Jackson: Well, let me ask this Francis.
Cianfrocca: That’s one thing. But the other, I’m sorry Brad. I just want to finish this point.
Cianfrocca: The key question I would have, if it were possible to have a conversation with the Tea Party, do you know that what you’re asking for is a cut in entitlements? Is a cut in Social Security benefits that you have paid for all your lives? And is a cut in Medicare? Because that is the only way to cut spending. Are you aware of that. That’s what I want to know.
Jackson: Well and the polls, there are several polls that say, no. That they think they can make cuts from elsewhere and don’t necessarily understand that a lot of that has to come from, from big programs that people rely on, which is why senior citizens, you know, might get upset at all this. But here’s the question I have for you, Francis.
Cianfrocca: Right. They’ll start marching.
Jackson: They will, in their walkers and all, I’m going to get in trouble for that.
Cianfrocca: Yes, you are.
Jackson: Here is the question I have. What happens if on August 2nd or 6th, or whatever the day is, what happens if we don’t extend the debt ceiling?
Cianfrocca: On that day?
Jackson: What if there’s not a deal and, you know, people put their foot down. They’re like no, we’re not going to do it. What happens that day or what happens the next day?
Cianfrocca: Okay. One of the things that people on the democratic side, they’re just enamored of saying this, well there’s going to be a default. And a sovereign default by the United States is completely unthinkable and the world will end. No. A sovereign default in which the United States would either fail to pay principle or interest on outstanding debt, bills, notes and bonds, would be something that Timothy Geithner certainly could do. And he could do it by choosing to take the, the Government is still getting Federal revenue from taxes. Okay. Borrowing is not their only source of revenue. There will be no default if they continue to, even if they use tax revenue on a priority basis to continue the debt service, which is an easy thing. We’re not talking about that much money. All right. In the overall scheme of what the Federal Government spends, service on outstanding debt is quite a small item. It’s in the low single digit percent. Okay.
So, no problem. It’s not a stretch to avoid a default. If Geithner, you know, prodded by his boss or possibly, you know, in an attempt to make Democrats happy in Congress, were to actually do that or credibly threaten to do that, I don’t know if he could. There’s probably a whole lot of law in place that would, you know, it would make that, you know, he’d go to Leavenworth. You know, they’d put him in Federal prison for doing that. So, I don’t think he could even get away with it. So that, default is off the table. What does happen is that the Federal Government will no longer be able to increase net indebtedness for the purpose of paying off their programs.
Now, I’m seeing some informal evidence, and this is based on personal business dealings, that the Federal Government or at least several or perhaps more than several, good chunks of the Federal Government have gone on a spending freeze. It’s like they’re slamming the brakes on all new spending. They’re continuing to honor the commitments they have to existing programs and existing payrolls, but they’re not really adding, they’re not adding anything new. I mean, they’re being quite aggressive about cutting spending and getting ready for the potential for a moment where somebody comes on and says you can’t spend another penny, other than, you know, payrolls. That could happen. It’s not sustainable in the slightest, because the amount of new debt that the Government is adding right now is over $100 billion a month. I mean, if you take the current Federal deficit, the current deficit only, just the deficit, which is what we would no longer be able to expand under a no debt ceiling increase, that amount of money is about the size of Social Security plus the Defense Department put together.
Cianfrocca: So would you like to, I mean, we could solve the debt ceiling problem right now. Let’s wipe out the, let’s close the Pentagon, ground all the airplanes, bring all the troops home, and fire them all. And let’s stop sending out every single Social Security check. That would work.
Jackson: Well –
Cianfrocca: You see the problem?
Cianfrocca: I mean, you see why this is not a solution. McConnell is talking about giving themselves another few weeks or months, that’s the same thing they’re talking about in Europe over, this weekend with the Greece situation. And you know, it gets a little, my primarily interest in politics is to keep them from screwing my life up. You get frustrated at a certain point looking at the basic behavior of political actors and they will avoid making tough decisions until the very last possible minute. And if they can avoid making a decision that is not forced upon them by circumstances, they like that all the better. All right.
So, you know, if we keep going down this road the objective, I’m sure that Senator McConnell and we’re making fun of him here a little bit, but I’m sure that he would very much as well as John Baynor in the House, they would very much like to have the kind of arrangement with the President and with the Democrats where we do have strong caps and forcible caps on spending as a percentage of GDP, people like Senator Cornyn and now James Baker in the Wall Street Journal are talking about 20.6% of GDP as a target cap for government spending. Right now it’s at 25%. It’s a huge way down. But as much as they would like to have this happen, until there’s a real crisis that you can perceive in Washington they’re not really under any pressure to do anything difficult. And so, you know, the expression you used Brad was, kicking the can down the road. Well, that’s what we’re going to get.
Jackson: Let’s talk about that piece that Baker had in the Wall Street Journal over the weekend. James A. Baker, of course, you know, a long –
Cianfrocca: Treasury Secretary under Ronald Reagan.
Jackson: Yes. Exactly. He’s been around the block a few times.
Cianfrocca: Quite a few times actually.
Jackson: He came out this week with something called, “How to Deal with the Debt Limit” and he actually has an interesting way of approaching this. He does step one, two and three. Let’s start –
Cianfrocca: It’s a three step program.
Jackson: It is. It’s a three step program. Let’s start with step one and let’s just go through this Francis, because I found this really interesting. He said, “Step one is to raise the debt limit in a way that generates confidence in the markets,” meaning that it has to include a restraint on spending.
Cianfrocca: I found it interesting and a little bit novel. Baker, of course, is a veteran of, you know, he was involved in a very big fight within the Reagan Administration that led to a major overhaul of the tax code. And he alludes to that, that’s his step number three.
Jackson: Yeah. He gets to that in a minute.
Cianfrocca: Yeah. The novel points about this, he’s talking about, and it’s interesting because we were just talking about McConnell with his few months, Baker says, let’s increase the debt ceiling in six month increments in order to keep the politicians with an immediate deadline in front of them. Because you know, given their druthers, they’d push it back beyond the next election and keep doing that until something blows up. Right. He says, keep it to a six month minimum and also have features in it that ensure to the markets that, that commit to the markets, that debt service is going to be the primary use of borrowed funds. Okay. Now, he raises a very contentious point. Okay. And remember, Baker, Reagan Administration, there was, the bond markets during the Reagan Administration and again during the Clinton Administration, had a very, very powerful impact on policy. Fiscal policy to the point that James Carvell (phonetic sp.) at one point, but you remember this. Carvell, early in the Clinton Administration said oh, (unintelligible) I’m going to beat the bond market because those guys have power over everybody. They can tell everybody what to do.
Jackson: So, in the span of just a short few minutes here you’ve done Mitch McConnell and James Carvell.
Cianfrocca: And James Carvell, but you remember that quote, right? And what happened was –
Cianfrocca: — when bond investors, who are, the people who are lending the money to the Treasury, when they get the sense that either they’re not going to get paid back or, well, or that there’s some risk of not getting paid back, or that they’re going to be paid back in less valuable dollars, meaning inflation, they raise interest rates. That’s rationale. I mean, you know, when you’re lending for 30 years, you know, a lot can happen in 30 years and you need to be covered for the risk. So, that increases the borrowing costs on the Treasury, and that’s the point James Baker brings up. And this is what I find interesting and a little, I want to make a point about it, because he may not be right. All right.
I’ve been talking to Wall Street’ers over the last few months and what people will tell you is, if we get, if the price of a real serious spending cap is a few days of uncertainty about, you know, the debt ceiling limit, we’ll take it. We’ll take it because if we know that fiscal discipline is for real, and is coming, even if it brings austerity, economic pain, which it will, that’s good for the bondholders and that will bring interest rates down. Okay.
So, Baker is saying if we don’t fix the fiscal problem our primary risk is an increase in interest rates which will make the fiscal problems worse, because with high interest rates that adds to your deficit problem. You know, it increases the amount of money you’ve got to come up with and keep borrowing. The hole gets deeper faster. And I’m not convinced that that’s actually going to happen, because of, just the market dynamics of the past couple of years. Very, very different from the Reagan years, or the Clinton years, or anything in history frankly. I mean, you know, there’s really no good reason why the 10 year Treasury note should be only 295 right now, but it is. So, you know, I’m not sure that that argument actually cuts it.
Jackson: Let’s talk about step 2, he kind of glosses over this. It’s only a paragraph, but I think it’s actually pretty important. He said, “Taking a page from Ronald Reagan’s playbook in ’86, restructure our convoluted Tax Code by reducing loopholes and lowering marginal rates.” He points out that this was a big help for businesses in the Reagan Administration in ’86 and it was something that really helped boost the economy.
First of all, you know, making tax arguments today, Francis, always revolves around two sorts of things. Flat tax and fat tax. How do you think, if we got into a discussion about reducing, you know, lowering marginal tax rates, reducing loopholes, how do you think that actually would turn out? What are the economics of that? Do you think people –
Jackson: Do you think that Democrats would say hey, we’re going to include a vat. I mean, how do you think that would shape up?
Cianfrocca: Yeah. I’m probably not the right one to ask, how it would shape up politically. It would be great to get Ben’s perspective on this. Economically the point that he’s making, that Baker is making is that if you simplify the Tax Code for business, as was done in 1986, you get a positive impact on investments and business activity. And Lord knows we need it. Whether or not, you know, I think it would certainly be a major step in the right direction. We need more than that though. The factors that are making, that are depressing business activity in the United States very much involve tax policy, but they involve other things as well like, you know, we still have never fully deleveraged from the housing crisis. We’re still –
Cianfrocca: — the consumer isn’t back. All right. So, if you improve a financial, and accounting, and tax policy issues for business, you will do a lot of good. Will you fix the economy? I’m not willing to say that it’s going to go all the way.
Jackson: Let me ask this question.
Cianfrocca: So, he’s making a good point and the point is certainly relevant to his own experience, but again times are a little different now.
Jackson: Let me ask this question. If it was Francis Cianfrocca the President right now, what tax changes would you propose in order to turn us around?
Cianfrocca: Well, first of all if I were President right now we would, I’m sick and tired of all this political stuff. I would just rule by decree and become Senator McCain. I mean, you know, listen. I’m a business guy. I’m used to getting stuff done. It’s like –
Jackson: Francis Cianfrocca, the autocrat.
Cianfrocca: What tax changes would I make?
Jackson: Yes. What would you do?
Cianfrocca: I believe that the capital gains tax, certainly for long term capital gains, should be zero. I think that the corporate tax rate should be no more than 10 or 12%.
Jackson: Which is a huge drop from where it is now.
Cianfrocca: Well, I don’t know where it is right now because it’s totally, you know, every company, basically large companies who are sustained continuous audit by the IRS, I mean the IRS pretty much has people living in all the Fortune 500 companies. You know, your tax rate on an effective basis is a matter of negotiation. I mean, the corporate tax, sure. It is. I mean, the corporate tax rate is 35%. That’s the marginal rate, but then you have all the various loopholes and the bizarre treatment of overseas income, which matters a great deal because US companies, the large companies, are doing so much of their business, nearly all of their growth, is happening in overseas markets. So, they can’t bring that capital home, so it might as well stay there. You know, you might as well, I mean that’s, in a funny way I look at that as capital flight. But it’s government driven. It’s not, the government is pushing it out and so all of those things could become a lot better with a drastic simplification in the Tax Code.
But look, it was Daley, Obama’s assistant in the White House who mentioned the other day, we were talking about this in the conversation he had at the National Association of Manufacturers where he said, you know, there are people that are, you know, on the other side of this one. Any kind of a change you make like that is going to have winners and losers. I mean, this is the point he’s making. And a great many people in large companies operate by lobbying in Congress. Frankly, that’s why we get laws that are 2,000 pages or 3,000 pages long that no one has ever read, because they are written by corporate lobbyists. And that’s how the Tax Code gets whacky. And you know, the Reagan reform that Baker was the center of sought to wipe away a great many of those complications and crustaceans that have, you know, crept in over the years. It really would be a high time to go through that exercise again and clear away all that croft (phonetic sp.). You know, the one thing you’d have to say looking at the current environment in Washington is it’s not built for action. So, I mean, that’s probably too much to hope for.
Jackson: Let’s wrap up with step number 3, he talks about the need for Congress and the White House to fully embrace free trade –
Cianfrocca: Free trade.
Jackson: — which is something that comes up.
Jackson: He says with the dollar at low levels consumers in other countries have an appetite for products with a Made in the USA label. He talks about Congress and the White House giving more than just lip service to free trade agreements with Columbia, South Korea, Panama, others. What would be the effect of this, Francis?
Cianfrocca: I think this is the most unusual of the three because free –
Jackson: It seems kind of out of left field, compared to the other two.
Cianfrocca: And why is it out of left field? Because nobody is talking about free trade any more. Free trade is one of those things that, it’s one of those bits of dogma like free markets themselves, that really kind of went away after the financial crisis. I mean, nobody talks about lassie faire any more. What we talk about is we had an approach to financial regulation, whatever the approach was, and you could characterize it in different ways according to political taste. What we know for sure is it didn’t work.
And you know, to the degree that it was based on, I would say people in economics, in the economics profession over the last 30 years were quite convinced by Milton Freidman and a great deal of the economic thought has been free market based and free trade based. And it’s all gone. It’s gone. It’s like a dirty word now. You don’t talk that way because we know it doesn’t work. I’m serious. I mean, this is, one of these days we ought to do a show about modern monetary theory, which I’m sure our listeners, most of them have never heard of and probably are glad of it.
Cianfrocca: But what Baker is saying here, one point is compelling. Even though the dollar, right now the value of the dollar is oscillating and it’s actually quite strong because the Euro is going through a lot of weakness. And you know, you see it in commodity prices. Commodity prices go up and down with the dollar and right now, this morning in Asia as we’re speaking and commodity prices are down somewhat, which means the dollar is probably going to be a little stronger tomorrow. He’s saying, given that the dollar is relatively weak this is very positive for American exporters, especially exporters of products made in America, interesting James Baker. Because he becomes Treasury Secretary in 1985, is that right? ’85 or ’86?
Cianfrocca: Okay. ’85 was the year of the Plaza Accord, a big agreement among the major industrial nations. They inked it at the Plaza Hotel here in New York. Ronald Reagan was there. And what was it about? The dollar was too strong. You know, anybody who is above a certain age may remember in 1983, ’84, and ’85, one of the big points of controversy was that the dollar was incredibly strong and it was killing all of our exporters. So they made this agreement primarily affecting Japan. Japan agreed to let their currency appreciate by about twice. By about two acts relative to the dollar. That touched off their bubble. And when the bubble crashed it touched off their last two decades that they’re still fighting through.
The Chinese saw that happen and they said to themselves, we will never let them do that to us. So, this is the experience James Baker is coming out of and again I think, you know, the value of the dollar, this may sound like it’s not that important. It’s very, very meaningful. Because you will see export flows, because the world runs on, you know, industrial products and industrial commodities are priced very sensitively. And you know, if the dollar moves half a percent on a given day, you will see trade flows shift. People will buy from other countries on that day in order to cash in the value.
Jackson: Really? It’s that immediate? It makes that big of an impact?
Cianfrocca: It’s immediate. Daily basis. Very, very sensitive.
Cianfrocca: Yes. Absolutely. Positively. And so not to, you know, not to downplay that point, but I think it would be really great for someone to come into office as President of the United States with a real free trade agenda that, you know, that not only, see, what does free trade mean?
Jackson: Yeah. Well, that’s what I was just going to ask.
Jackson: What would a real free trade agenda mean?
Cianfrocca: In the American context free trade usually means convincing other countries to drop their trade barriers against us. Because our trade barriers, there are some, but they are generally much lower than they are against other countries. And also, politically weird. I mean, even President Bush got beat up for putting on steel tariffs. Every country plays this game, but I will say not to make, you know, not to put too fine a point on it, we’re less bad than most other countries. We’ve been trying to negotiate a free trade agreement with South Korea for like three years now, and Obama just, has no interest in this. He’s talking about it. His people keep saying oh, you know, we’re going to do it. We’ve got to sign, all the points are agreed to. It’s just a matter of doing the signing ceremony. They’ve said that a couple of times now.
In the meantime what are the Koreans doing? And South Korea is one of the most dynamic economies in the world right now. They’ve suffered very little from the crisis. They’re making deals with China because they’re having to wait for us. We’re losing business. We’re losing business over this. And you know, if you could just get the lead out and make these deals with these countries. Columbia in South America which ought to be a close ally, we’re pushing that away because the usual barrier to doing a free trade agreement is the labor union movement in the United States. Okay. It’s labor and it’s environmental concerns, because people will come up and they’ll go to the Democratic congressman and they’ll say, no free trade agreements with Columbia or South Korea unless they agree to subject their workers to the same stupid, and expensive union rules, and environmental regulations that we have to live by. And if you’re some other country with options, with alternatives, you don’t need to do business with the US because China is right there. Okay. Here’s the US saying, we’ll do a free trade agreement with you, sure. No problem. Except you need to raise your labor costs to match ours. They’ll say, what, are you crazy?