Last week’s economic news could not have been better. Gross Domestic Product, the measure of the overall size of the economy, grew at an annualized rate of 3% over the second half of last year after having declined over the previous two quarters. While there are myriad measures of inflation, the most common measure, the Consumer Price Index, rose at an annualized rate of 1.8% over the same period – it actually declined by 0.1% in December – after having jumped 9.1% over the previous year. And despite over 200,000 layoffs in the tech sector over the last year, the unemployment rate continued to edge downward to an historical low of 3.5%, while wages grew by over 6%, and reached double digits for the lowest-income workers.
All that news came in the face of the Federal Reserve Bank’s year-long efforts to bring inflation down by bringing the economy to heel. It is hard to imagine the economic news could have been stronger; inflation has come down, but the economy is continuing to roll along.
Six months ago, in a survey of 400 corporate leaders by KPMG, 90% believed that a recession in 2023 was inevitable and more than half thought the downturn was likely to be long and severe. Now, that sentiment has changed dramatically. As news over the past week suggests, it seems increasingly likely that we will avoid a severe downturn. Even Fed antagonist Larry Summers, who warned last summer that taming inflation would require unemployment north of 6% for several years, has tempered his predictions.
Against the backdrop of an economy that appears to be steadily emerging from three years of pandemic-induced turmoil, House Republicans sit with their finger on the trigger of a nuclear bomb, threatening to blow it all up. And the nuclear bomb analogy is an apt one. Moody’s Analytics chief economist Mark Zandi – who for decades has been among the most respected economic analysts – warned last week that a failure by Congress to raise the debt ceiling on a timely basis could have disastrous consequences.
Specifically, Zandi suggested that even in the event of a brief impasse forcing the country to default on its obligations, GDP would decline by 4%, nearly 6 million jobs would be lost, and stock prices would slide by a third. And beyond Zandi’s numbers, the consequences of a U.S. default would ripple across the globe in less quantifiable ways. Much of the global economic system takes U.S. fidelity to its obligations for granted, as Treasury securities are the presumptive risk free obligations upon which systems of credit and collateral across the world are predicated.
Suffice it to say that there is little evidence that such dire consequences of a U.S. default have deterred the self-serving instincts of the radicals that Kevin McCarthy has put in charge of his caucus. For all their laudable talk about restoring “regular order” to Congress – the traditional system under which legislation is debated and passed through the committee process – they have no interest in the process of debate and compromise that is the essence of constitutional governance. Instead, they proved earlier this month that they are, at their core, hostage takers who will use any means at their disposal to get what they want. For Texas Congressman Chip Roy, this means using the debt ceiling vote to force changes in the Biden Administration border policies that he has been unable to win through the regular order that he says he stands for. For others in the oddly named “Freedom Caucus,” it means threatening Armageddon over a debt ceiling increase which never bothered them when Donald Trump was setting records running up the public debt. For Matt Gaetz, Andy Bigg, and Lauren Boebert, it is, like everything else, about little more than attention-seeking and fundraising.
Yet for all the yelling and screaming, the threats and counter-threats in Washington DC, thus far the markets are paying little heed. When asked last week about his views on the debt ceiling, Ray Dalio, founder of the world’s largest hedge fund and a widely regarded observer on the state of the world, suggested that the debt ceiling crisis is a “farce,” a recurring event of performative political theater that is detracting attention from the genuine threat posed by the global rise of populist and nationalist forces, and the dangerous consequences of the “fading away” of the post-World War II dollar-based economic order.
In a similar vein, in an interview last week in Bloomberg, legendary contrarian investor Jeremy Grantham was surprisingly upbeat on market prospects – an unusual stance from a person for whom the sky is always falling. While Grantham believes there is some risk of a further 15% pullback, he emphasized several forces that could push markets higher over the coming year – including the increasing likelihood that the economy will not fall into recession, and that the Fed will end up pivoting on interest rates sooner than expected. He also noted that U.S. politics loomed to be a positive for the markets, as looking back over the past 100 years, the seven months beginning the October before midterm elections and ending the following April have produced far better stock market returns than any months in the four-year political cycle. As to the risk of an apocalyptic debt default? Nary a mention.
None of this is to suggest that brinkmanship at the federal level will not take its toll; it is simply that, as Ray Dalio observed, this is the 79th time since 1960 that the debt ceiling will have been reached, and far from the first time that there has been political posturing in advance of dealing with it. This week, in Guggenheim Investment’s report “10 Macro Themes for 2023,” the debt ceiling issue crept in at number 10: Divided Government and Narrow Majorities Will Spur Debt Limit Drama. The report’s conclusion reflected the sanguine market attitude to date:
“While we do not expect a default, the standoff is likely to go until the last minute, possibly resulting in a reprise of the 2011 debt limit debate, which led to a U.S. credit rating downgrade and a market selloff. The debate could also result in a government shutdown, which would worsen the market impact.”
The simple fact is that if Republicans want to be a credible governing party, Kevin McCarthy cannot allow the United States to default on his watch, and over the weeks ahead, there are two people who will likely play outsized roles as he navigates his way to a solution. One is Marjorie Taylor Greene. Greene is McCarthy’s link to the MAGA wing of the party, which she has accurately described as now representing 70% of the GOP. But she was not one of the party rebels against McCarthy’s speakership; instead, she was perhaps his most important wingwoman. She had already made her deal with McCarthy, and he is her path to power. So when the time comes that McCarthy has to round up the votes to move a debt ceiling deal forward – particularly as it is likely to mean allowing a deal to pass with Democrat votes – he must fully expect Greene to have his back.
The second person is Ken Griffin. Griffin, the founder of Citadel Asset Management, is among the wealthiest people in the financial world. With the death of Sheldon Adelson, Griffin has become the largest contributor to Kevin McCarthy’s Congressional Leadership Fund PAC. More a globalist of the Dalio school than MAGA Republican, Griffin supported Barack Obama in 2008 and Mitt Romney four years later, but declined to contribute to Trump’s campaign in 2016.
Raising and distributing money to Republican congressional candidates has been the key to Kevin McCarthy’s rise to Speaker. And in the 2022 campaign cycle, when McCarthy raised and distributed $260 million, Ken Griffin contributed almost 10% of those funds. As the manager of a gigantic, multinational hedge fund, Griffin’s focus over the years, like Dalio’s, has been on the impact of actions in Washington on global markets and the stability of the US dollar. Indeed, in 2018, he famously lashed out at Donald Trump for his attacks on Fed Chair Jerome Powell, which Griffin feared were eroding the “stature of our currency in global markets and to the faith and confidence people have in the value of the dollar.” And nothing would contribute to the erosion of faith and confidence in the dollar more swiftly than a U.S. default in the wake of a failure by Congress to address the debt ceiling.
Last week, the markets pushed upward as the news was pouring in that the economy was outperforming expectations. Yet, the closer to the brink the grandstanding goes, the more volatile the markets are likely to become. Not because the Ray Dalios or Jeremy Granthams of the world are going to panic, but because much of the rest of us may. At the end of the day, although we may get to the brink, we will not go over it. One has to imagine that at some point, before the nonsense on Capitol Hill is allowed to crater the economy and accelerate the unraveling of the dollar-based economic order, Kevin McCarthy’s phone is going to vibrate, and Ken Griffin will be on the line. And when that moment comes, McCarthy will understand that whatever price might have to be paid, it will be time to get the deal done.
David Alexander Paul
David is the President of Fiscal Strategies Group and was previously Managing Director of Public Financial Management, a public and project finance subsidiary of Hongkong and Shanghai Bank. He also served as the Vice Provost of Drexel University. He founded and served as CEO of Mathforum.com, a mathematics and math education Internet company and virtual community.