The risk of an accidental financial meltdown has been increased sharply by the latest “kamikaze” tactics of Republican budget negotiations, according to warnings given to Congress by leading economists.
The House of Representatives is expected to pass a resolution on Friday that will allow government spending to continue beyond September only if funding is withdrawn from Obama’s new healthcare initiative.
With little chance of Democrats in the Senate or White House agreeing to abandon the president’s flagship domestic reform, the vote sets up 10 days of tense political brinkmanship that could lead to a partial government shutdown.
House Republicans are also threatening to refuse to extend US borrowing limits when they are breached in mid-October unless other concessions such as tax reform and oil pipeline permits are granted too.
A similar fiscal showdown was resolved in December when Republican leaders struck a last-minute, temporary deal with Democrats, but this time the GOP leadership has been forced to bow to more radical conservative groups in the House, making compromise much harder.
Even conservative voices such as the Wall Street Journal have criticized the new Republican strategy by writing “Kamikaze missions rarely turn out well, least of all for the pilots.” The phrase has been widely repeated in Washington this week.
Experts warn the danger of an accidental government shutdown or debt default is now a serious risk to the fragile US economy.
Mark Zandi, the chief economist at Moody’s Analytics and a former adviser to Republican senator John Mccain, told a hearing of the joint economic committee: “You can only put the gun to your head so many times before someone is going to make a mistake and pull the trigger.”
Financial markets have so far been unruffled by the latest congressional showdown, with many traders assuming that a last-minute deal will again be struck, but the committee was warned that Wall Street may have been lulled into a false sense of security.
“Policymakers should not take solace in this,” added Zandi in written testimony on Wednesday. “If they botch it and the government shuts down or fails to meet its obligations, investor and consumer psychology will be damaged and the economy will suffer serious harm.”
Theoretically, a refusal by Congress to extend the debt ceiling need not lead to immediate default, since the US Treasury could prioritise certain interest payments and postpone non-urgent spending, but such a juggling act would bring substantial risks of its own, according to the expert panel.
“Congress should keep in mind that accidents can happen,” said Donald Marron director of ecomomic policy at the Urban Institute. “In 1979, for example, the Treasury accidentally defaulted on a portion of the debt in the wake of a debt limit showdown. Nonetheless financial markets reacted badly … [and] significantly boosted the government’s borrowing costs.”
Any disruption could be worse this time, because markets are acutely sensitive to threats to supposed safe havens such as US Treasury bonds following the banking crash.
“Anyone who remembers the financial crisis of five years ago should shudder at the thought of disrupting these markets again,” added Marron.
Similarly, the impact of a government shutdown would theoretically be limited if it only lasted a few days, because just a third of the US budget is discretionary spending funded through congressional appropriations.
Zandi estimates that a three- or four-day shutdown would reduce economic growth in the fourth quarter by a fifth of a percentage point.
However, shutting the government down for three or four weeks would do significant economic damage, reducing GDP by 1.4 percentage points, said Zandi.
“And this likely understates the economic fallout, as it does not fully account for the impact of such a lengthy shutdown on consumer, business and investor psychology” he added.
House speaker John Boehner insisted on Wednesday that such scenarios remain unlikely, implying that a deal will be struck when the Republican budget bill returns from the Senate with the controversial healthcare veto removed.
“There should be no conversation about shutting the government down,” Boehner told reporters during a press conference to announce the new Republican strategy. “That’s not the goal. There is no interest in our part in shutting down the government.”
But what remains unclear is whether Boehner can count on enough members of his increasingly radicalised party to vote with Democrats and pass a budget bill second time around if it is stripped of all their demands.
There is also a chance that fiscal conservatives in the Senate may filibuster efforts to pass the budget bill there. Although he has a majority of Democrats, Senate leader Harry Reid is short of the 60 votes needed to block a filibuster without the help of Republicans such as John McCain.
Senator Ted Cruz said he wants House Republicans to continue to stand their ground on defunding Obamacare even if it is blocked by the Senate.
“Harry Reid will no doubt try to strip the defund language from the continuing resolution, and right now he likely has the votes to do so,” Cruz said in the statement on Wednesday night.
“At that point, House Republicans must stand firm, hold their ground, and continue to listen to the American people.”
But this only angered some Republicans in the House who believe their colleagues in the Senate are being too defeatist.