It's Debt-Ceiling Madness Again. Why You Should Stay Calm (Sort Of)

Torian/Shutterstock.com

The nation’s borrowing limit will be reached once again on May 19. Even though the Treasury Department can take so-called extraordinary measures to push the real deadline for default out to sometime this summer, it sounds an awful lot like 2011 when the country stood ready to default. But a feeling is growing among some economists and political experts that the markets won't be as jittery this time.

In 2011, U.S. markets slid 15 percent between the week leading up the Aug. 2 deadline for raising the debt limit and the early days of trading after credit-rating agency Standard & Poor’s cut the country’s top rating due to the debt-limit fighting. Congress temporarily suspended the debt ceiling with much less fanfare in February.

What's changed in 2013 is the politics. 

Analysts at Eurasia Group say that's because both sides are willing to go small. “Obama will use his budget to renew calls for a 'grand bargain' that remains out of reach; ultimately he will sign either a short- or a long-term debt-ceiling increase later this year,” they wrote in a recent research note. “Republicans will present an initial hard-line position on their debt-ceiling demands, but will ultimately accept a smaller debt-ceiling increase if a bigger deal cannot be agreed.”

“While rhetoric will heat up and negotiations will drag through the summer, we expect that well in advance of a likely August deadline it will become clear Washington is choosing between a small or a large debt-ceiling increase rather than a fiscal deal or default, which should put a floor under market concern,” they said.

The rhetoric has already begun to heat up. Sen. Rob Portman, an Ohio Republican, said Tuesday that the debt limit has “been, frankly, the most effective way” to talk about deficit reduction. “I think this is an opportunity and I think the timing is actually pretty good,” Portman said at a breakfast hosted byPolitico. “So let’s deal with it, let’s use the debt limit, you know, as leverage.” 

House Republicans, for their part, have indicated a desire to move forward with legislation that would direct the Treasury Department to prioritize payments in the event the debt ceiling is reached. Democrats say this is an attempt to minimize the impact of reaching the debt limit. 

But if analysts feel that some sort of agreement to raise the ceiling in advance of the deadline is more likely now than it was two years ago, the economy could change that.

“If the economy were to suddenly soften, I think that might make a [fiscal] deal less likely because people would say ‘enough already’ [with deficit reduction],” said Greg Valliere, chief political strategist at the Potomac Research Group. 

Although economic data of late has been softer, the economy is stronger than it was in 2011, and better able to withstand shocks. Still, if it does come to an eleventh-hour showdown over the nation's creditworthiness this summer, a la 2011, economists have mixed views about how markets would respond. 

Some say markets are tired of lurching from crisis to crisis and would be less jittery in response to the latest fiscal fight. The country has definitely seen its share in recent years: the spring 2011government-shutdown fight; the summer 2011 debt-ceiling showdown; the winter 2011 payroll-tax debate; the winter 2012 fiscal-cliff fight; the debate over the March 1 automatic spending cuts known as sequestration.

Europe has also had its share of crises, most recently the tempest surrounding Cyprus’s banking sector and whether the measures to keep Cyprus afloat set a dangerous precedent for the rest of the eurozone. “We’ve just had a lot of crisis fatigue,” said Joseph LaVorgna, chief U.S. economist at Deutsche Bank.

“We’ve gone through a number of these things and it does seem likely that at this point, until there’s a reason — a very clear reason — to worry about a failure to increase the debt limit, markets may assume that it simply will happen,” said Alec Phillips, an economist at Goldman Sachs. 

Not everyone agrees. Research from the Federal Reserve Bank of New York suggests that a new debt-ceiling showdown could be worse than 2011, not better. “The relatively benign effects of the 2011 U.S. debt-ceiling crisis on U.S. financial markets appear to have been serendipitous, as the U.S. and European debt crises occurred concurrently,” Fed economists wrote in a post last month, referring to very real fears that Greece would collapse and bring the euro down with it.  “Money funds nevertheless reacted to the increased riskiness of Treasuries by dramatically decreasing the maturities of Treasuries held in their portfolios during the debt-ceiling crisis. This behavior suggests that we can’t be sure that the effects of future fiscal crises on financial markets will be similarly benign,” they continued.

Of course, the calculus completely changes if the country actually fails to raise the debt limit and enters into default. Pretty much everyone agrees that would be very, very bad for the economy, calling the country's creditworthiness into question for the first time in history. But — at least at this point — that doesn't seem likely.

(Image via Torian/Shutterstock.com)

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