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Democrats Play A Weak Hand

Our U.S. senators are on standby at the Capitol this morning, sacrificing their Independence Day recess to show that they are ready to act on a deficit-reduction package that is nowhere in sight.

Members of the House of Representatives have the day off.

While the Democrat-controlled Senate abruptly canceled this week’s recess to back up President Obama’s demand that Congress act quickly on the deficit and the federal debt limit, House Republican leaders were not inclined to ruin a long holiday weekend just to put on a show. Besides, the House was scheduled to be back in session tomorrow anyway, unlike the Senate, which had planned to take this entire week off.

As the clock ticks down to Aug. 2, when the Treasury says the national credit line will be maxed out, each political party accuses the other of posturing, which is true, and of blindly following its core ideology, also true. The political branches of government, like the electorate, are split more or less down the middle over two conflicting sets of priorities. Republicans want to cut as much federal spending as they can, and Democrats, though conceding that they will have to cut a lot, want to preserve as much as they can.

Although the split is fairly even, Republicans have a decisive advantage in the battle over what mix of spending cuts and tax increases should accompany any rise in the debt ceiling. The simple fact is that Democrats want to raise the debt limit a lot more than the Republicans do. It is not a coincidence that the Democratic Senate is at the office today, while the Republican House enjoys an extended holiday.

In politics, as in business and many other areas of life, the side with the greater desire to complete a deal usually ends up making most of the concessions.

I learned this a long time ago by observing an elderly man, a former high-powered executive, who signed a “reconciliation agreement” to get back his one-time trophy wife after she left him. The agreement gave her a large annual stipend, the home of her choice, and specified time off each year so she could spend time with her friends. In return, she stayed in the marital home and, in my direct observation, treated her husband like dirt. He knew she treated him like dirt, but insisted to his dying day that he preferred the arrangement to being alone.

After a free-spending period while George W. Bush occupied the White House, Republicans have caught the balanced-budget fever, so much so that they are calling for a constitutional amendment to mandate a balanced federal budget. A constitutional amendment would be a terrible idea, because it would put government policy in a straitjacket. It also has no chance whatsoever of passing, so Republicans can call for it without having to worry about living with the results.

But refusing to raise the federal debt ceiling would accomplish pretty much the same thing as a balanced budget amendment. Instantly, Washington would have to limit the amount it spends to the amount it takes in. New money could be borrowed only as old debts are repaid. Because of the considerable interest expense on more than $14 trillion of existing federal debt, current spending on government programs would have to be slashed to a level well below what the government collects in taxes.

Balancing the budget cold-turkey like this will mean an immediate cut of more than 40 percent in federal outlays, a cut so large that the consequences would have to be immediate and drastic. Benefits like Social Security probably would not be paid in full and on time. Men and women in military service might miss a paycheck, too. Farm programs, highway construction, student loans and other federal outlays would dry up. Trade and transportation might be disrupted as customs and immigration workers are furloughed. Forget about all that stepped-up border security. If we really have to choose between defending against terrorists and defending against busboys and gardeners, the latter are going to make it into the United States.

Will failing to raise the debt ceiling automatically throw the country into default as the Treasury fails to meet its obligations? The administration says yes, raising the threat of financial Armageddon if the national credit rating is cut, which would be an immediate and unavoidable reaction to any default.

Default, however, would be a choice rather than a consequence if the debt ceiling stays where it is. The Treasury will still have ample money coming in to pay interest on government obligations as they are due. Maturing debt can be replaced with new debt. If nobody else will buy that debt, we can be pretty confident the Federal Reserve will. Credit rating agencies don’t care about any delay in Social Security payments.

Nobody wants any of these drastic things to happen. Even the Republicans who are calling for a balanced budget amendment are not calling for an instantly balanced budget.

But many in the GOP would be prepared to live with these consequences, even another severe recession, if it meant establishing long-term control over federal spending. For Democrats, on the other hand, failing to raise the debt ceiling and keep the federal money spigot open would be an unmitigated disaster. The poor, elderly and working class Americans that Democrats claim as their base would suffer the worst financial harm, and the party’s chance of keeping control of the White House and Senate next year would be virtually nil. Obama would go into next year’s campaign as a modern-day Herbert Hoover.

So while both sides want a deal, only one side desperately needs one. When you have a weak hand, the only things you can do are bluff or fold. Right now Democrats are bluffing, saying, as the president did again over the weekend, that any agreement will have to include tax increases as well as significant spending cuts. Republicans, who have no need to bluff because they hold most of the good cards, are not buying it.

Obama and his allies will ultimately have to fold, as they did in December when the president agreed to extend all of the Bush-era tax cuts for two years despite opposition from many is his own party. I don’t think the final deal on the debt ceiling will include any broad-based tax increases. The only question is how long it will take, and how much damage will be done, before everyone lays their cards on the table.

Larry M. Elkin is the founder and president of Palisades Hudson, and is based out of Palisades Hudson’s Fort Lauderdale, Florida headquarters. He wrote several of the chapters in the firm’s most recent book, The High Achiever’s Guide To Wealth. His contributions include Chapter 1, “Anyone Can Achieve Wealth,” and Chapter 19, “Assisting Aging Parents.” Larry was also among the authors of the firm’s previous book, Looking Ahead: Life, Family, Wealth and Business After 55.

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