Republicans, led by House Speaker Kevin McCarthy, insist on government spending cuts as a condition of letting the US government borrow more money to pay its bills. Team McCarthy will probably get those spending cuts. In the end, however, Congress is likely to undo its own spending discipline, just as it has done before.
There’s a well-rehearsed playbook for the debt-ceiling theater Republicans and Democrats are forcing the nation to endure. Spoiler alert: It will end with a deal to cut federal spending that Republicans will declare heroic and Democrats will deride as unnecessary. In the future, however, Congress will renege on any spending cuts likely to be unpopular, underscoring just how absurd and pointless the whole debt-ceiling exercise has become.
The template for a solution to the debt-ceiling standoff in 2023 is the debt-ceiling deal of 2011. That has gotten a lot of attention lately as investors try to anticipate market dynamics as the “X Date,” on which the Treasury Dept. runs short of money, draws closer. In 2011, Congress didn’t finalize a deal until about three days before Treasury would have been forced to leave some bills unpaid. That was way too close for comfort.
The S&P 500 stock index (^GSPC) dropped nearly 7% during the two weeks leading up to the finalization of a deal on August 2, 2011. The deal produced no relief rally, with stocks sliding another 4.4% during the next three trading sessions. Then, on August 5, Standard & Poor’s cut the US credit rating by one notch, pushing stocks down another 6.7% in a single day. Stocks didn’t bottom until October, for a total peak-to-trough decline of 19.4% that year.
One reason the market didn’t celebrate the end of the debt-ceiling standoff in 2011 was the spending cuts contained in the Budget Control Act, the law Congress passed to allow more federal borrowing. The BCA included roughly $1 trillion in spending cuts during the next decade and it set up a “super-committee” of legislators charged with reducing future deficits by another $1.2 trillion. If the committee couldn’t come up with spending cuts Congress could pass, “sequestration” would happen, meaning automatic cuts in many government programs, including Medicare and national security funding. The automatic cuts would have been large enough to impact economic growth and hamstring sectors reliant on government spending, such as defense and health care.
The super-committee failed, naturally, triggering the automatic spending cuts. Except that’s not what Congress intended, really. Sequestration was supposed to be so draconian that the super-committee would come up with something better. Since it didn’t, Congress managed to water down sequestration and many of the other spending limits in the BCA during the years that followed.
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“Congress and the president repeatedly enacted legislation increasing the spending limits, thereby counteracting some or all of the reductions required,” a 2023 Congressional Research Service report found. Congress, for instance, passed laws in 2013, 2015, 2018 and 2019 that superseded or obviated the BCA limits. Those laws were largely bipartisan, with both Republicans and Democrats essentially overruling the 2011 limits.
The National Taxpayers Union found that during the 10 years the BCA was supposed to be in effect, Congress “cheated” by authorizing $808 billion in regular spending above the 2011 limits. It also approved $1.9 trillion in additional spending exempt from the BCA caps, because that was “emergency” funding needed for overseas military operations, Covid stimulus and disaster relief. On the whole, the BCA did limit spending a little. Yet since 2011 the national debt as a percentage of GDP exploded anyway, from 96% to 125%.
Could it be different this time? Could Congress impose real spending cuts and stick to them?
Ha funny! No chance!
Budget watchers fully expect a 2023 deal to include spending caps that Congress can override in the future, exactly as they have before. One familiar trick is setting tough budget targets several years down the road, knowing intervening developments will likely render those targets moot, and hardly anybody will remember, anyway.
“Everyone in DC knows the caps get more fake further in the future, since they can always be raised (as they have been in the past),” Tobin Marcus of Evercore ISI wrote in a May 22 analysis. “Longer caps mean more on-paper savings, but may never really create any austerity thanks to the ease of revising them. We would urge investors to largely tune out the debate over this parameter.”
That suggests markets will not react as sourly to the prospect of deep spending cuts as they did in 2011. There are other reasons 2023 won’t be a repeat of the 2011 market swoon. Back then, there were a lot of other things going wrong at the same time Congress went to the wall on the debt limit. A European sovereign-debt crisis was contributing to global instability and short-term interest rates were still near 0 in the aftermath of the Great Recession, leaving the Federal Reserve no room for further rate cuts if necessary to offset a downturn. The global economy is more robust today and with short-term rates around 5%, the Fed has ample room to cut.
Congress and President Biden will either have to make a deal soon, to avoid a federal funding shortage that could arise in early June, or pass a short-term borrowing extension allowing them to make a deal later, with a little more time to negotiate. One way or another, Congress seems likely to cut spending as part of a final deal to allow more borrowing that’s likely to last until 2025. Then they’ll quietly start the process of undoing their own deal, bit by bit, in small slices they hope nobody notices.
Rick Newman is a senior columnist for Yahoo Finance. Follow him on Twitter at @rickjnewman
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