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President Barack Obama’s best hope of re-election lies in provoking Republicans to force the United States into technical default, engineering a brief but severe financial crisis in order to appear as crisis-manager-in-chief. The Tea Party movement may be marching into a political ambush, in which Obama will be able to portray the born-again budget-cutters as irresponsible fanatics who threaten to tip America into a new depression. The now unpopular president then would assume the role of national savior in time of crisis.
What would happen if August arrives without an increase in the US debt ceiling? There is no good reason for a new financial crisis to erupt. But there are bad reasons. The standard scenario was rehearsed July 15 on the Financial Times’ Alphaville blog,  which notes that “the United States runs a monthly fiscal deficit totaling $124bn, and that there are almost $60bn of T-bills maturing in the two weeks after August 2, all requiring redemption payments. (Plus a $20bn coupon payment on August 15 – Fitch has said this would be the trigger for restricted default, if missed.)” Technical default is likely, and so perhaps, as the rating agencies have threatened, is permanent loss of America’s AAA rating.
The bigger danger lies in the “vast role Treasuries serve as collateral – a role which usually sees them safely locked up in the day to day operation of the money markets, but which we already know is vulnerable to a sell-off – a Lehman, 2008-style margin spiral – in the event of the debt ceiling remaining in place. You’d hardly wait for ratings agency downgrades.”
The market for repurchase agreements (short-term loans against bonds) amounts to $4 trillion globally. If banks, hedge funds and others who borrowed against bonds had to put up more collateral because Treasuries were in trouble, they would have to sell huge volumes of securities into a falling market. That is what happened after the Lehman failure in 2008.
Just how that might transpire is up to the central banks. After 9/11 the central banks offered unlimited amounts of short-term financing against any dead cat that financial institutions cared to offer as collateral. There are no automatic triggers in such things: ultimately the question of what collateral is good depends on the say-so of the monetary authorities.
In that event, the Obama administration would declare an emergency, summon bankers to Washington for crisis-management sessions, slash every form of spending except for coupon payments on Treasuries, and so forth. Markets would swoon over the uncertainty. And the president would be on television denouncing the lunatics who brought things to this point. Congress would pass emergency legislation, markets would snap back, and Obama would declare himself a national savior.
Obama, meanwhile, would play the populist against the banks, demanding tougher government controls, consumer protection, and perhaps even the right to dictate that banks make loans to the Democrats’ pet projects in the name of job-creation (just as the Clinton administration forced banks into the subprime market, supposedly to help poor people buy homes).
No good crisis should go to waste, Rahm Emanuel said. As Stanley Kurtz documented in his 2011 book Radical-in-Chief , Obama is a socialist of pure pedigree, trained by socialists from his university days and promoted by a nexus of socialist foundations in Chicago throughout his political career. He passed up an opportunity to nationalize American banks in March 2009, when Paul Krugman, Simon Johnson and other leftist economists urged him to do so. Evidently he thought that a compromise with Wall Street would benefit the economy and improve his chances of reelection. That did not pan out, and Obama has nothing to lose by running against Wall Street. A new financial crisis would give him the opportunity to do so.
If I were an Obama speechwriter, here’s what I would put on the teleprompter after a federal default, as stock markets tanked and individuals cashed out their money market funds:
My fellow Americans, the Republican party has been in the pocket of the big banks for too long. After the last Republican administration led the country into the worst economic crisis since the Great Depression, you elected me to restore the balance in favor of working people. Now the Republicans have pushed America into yet another crisis, and again we are faced with the danger of depression.
In consultation with the Federal Reserve and world leaders, I have taken emergency measures that ensure that the irresponsibility of big financial institutions and their Republican friends will not harm your job, your pension or your bank account. And I am sending Congress a set of emergency reform measures to ensure that the banks put the needs of ordinary people ahead of their own fat bonuses.
The economy will continue to bounce along the bottom, but Obama will have someone to blame other than himself.
Senator Mitch McConnell (Republican, Kentucky) has the right idea: put the onus on Obama. The fact is that the American people elected a president who occulted his leftist proclivities, and then, with buyer’s remorse, returned a Republican House and a near-majority in the Senate. The American political system does not allow for a clean victory by either side: it can produce either a crisis or a compromise. In a crisis the executive authority holds all the aces, because only the executive can act to alleviate the crisis.
The Republicans, rather than shutting down the government, should say something like this:
President Obama has doubled the national debt. If we do nothing, the national debt will rise by another $3 trillion, even if you elect a Republican president in 2012 on a program of fiscal responsibility. You the people elected a Republican majority in the House in order to stop this from happening. We have offered a workable plan to the President, but he demands things that we know our constituents don’t want – tax increases to fund white-elephant pet projects like high-speed rail. He is threatening to shut down the government in order to get a tax increase. The trouble is that he’s the president, and he can do it. So we are offering him authority to continue borrowing. The 2012 election will be a referendum on this country’s economic future. It’s tragic that we have to lose an opportunity to staunch the bleeding right now, but that’s how our constitutional system works.
The Republicans would then have a year and a half to run against Obama’s irresponsibility – his incompetent economic management, his demands for tax increases, his failure to address the deficit. The big problem is restoring growth. Reducing the budget deficit won’t help much – not when the Treasury can borrow 10-year money at only 3%, and homebuyers as well as blue-chip corporations can borrow for just a percentage point more.
The old supply-side magic (cutting capital gains and corporate tax rates, for example) would help, but not in the spectacular way that the Ronald Reagan tax cuts helped in the early 1980s. Taking the top federal tax rate on personal income down from 70% to 40% made a huge difference. Back in 1984, the baby boomers were in their 20s and 30s, not their 50s and 60s. The US had a 10% personal savings rate (compared to zero during most of the past 15 years), as well as a current account surplus. And America was the world’s only credible venue for entrepreneurship, the main destination for the world’s financial as well as human capital. It’s harder to climb out of the hole today.
Obama has made things worse. His health care program will impose heavy fines on businesses with more than fifty-five employees that fail to offer health care – an incentive to keep your payroll below that number. The trillion-dollar “fiscal stimulus” exposed the bankruptcy of the academic Keynesians, and firing Larry Summers, the former Harvard president who headed his economic team for the first two years of his administration, didn’t win Obama any points.
The liberal punditeska heaps contempt on the Tea Party as a bunch of dumb yahoos. If they’re so dumb, though, why are they so powerful? The fact that a ragtag army of political amateurs could overturn the status quo in the 2010 elections shows that their unifying issue has legs: people don’t want to pay taxes to cover budget deficits that pay outsized benefits for other people. That’s why Republicans are crushing the public-employee unions in Wisconsin, Minnesota, New Jersey, and other fiscal battlefields, and why smart Democrats like New York’s Governor Andrew Cuomo have been born again as fiscal conservatives.
But the Tea Partiers remain amateurs, after all, and vulnerable to sucker punch. They don’t seem to understand that the separation of powers is designed to slow the pace of change. A Republican administration, moreover, can’t govern on the Tea Party program. It is a protest movement, and a valid one, but not a governing coalition. If the Tea Party expends all its ammunition in the debt-ceiling showdown with the President, it may take the Republicans down with it. The winning strategy is to keep the blame for failure on Obama through November 2012.