Last week’s budget wrangles in Washington remind me of reality TV. You watch it like you watch a train wreck. While Republicans and Democrats have (temporarily) avoided shutting down the federal government, you almost wish they wouldn’t have. At least then, they would have been forced to confront the economic consequences of their own political gridlock before reaching the next and much bigger deadline – the raising of the deficit ceiling, which may need to happen as early as five weeks from now if Geithner can’t find a way to move money around the books to cover things until July.
When the deadline comes, if we see the kind of absurd political infighting that we’ve seen over the past few weeks around the budget, the consequences could be much, much more deadly, and not just for the U.S. If we’d have had a government shut-down last week it wouldn’t have been good – lots of people would lose their jobs, and growth could contract as much as a percentage point. But if America were allowed to default on its national debt (which would be the consequence of not raising the debt ceiling) for even a day or two, it could trigger a bond market collapse, a spike in global interest rates, and a financial fiasco that could make the collapse of Lehman Brothers look tame. The fallout could very well throw the world back into recession.
As Larry Summers put it to those of us attending the conference of the Institute for New Economic Thinking, which is sponsored by financier George Soros, in Bretton Woods this weekend, “not meeting our debt obligations is like allowing a child with matches to sit in a room full of dynamite.” He added, “I continue to find it close to inconceivable that elected policymakers would allow the risk of default.” So do we all.