http://www.reuters.c...E75700720110608An increasing number of Republicans do not believe the Obama administration's dire predictions of economic "catastrophe" if the debt limit is not increased. They argue a period of technical default can be managed without plunging markets into chaos.
IMO, this would be a reckless move. First, the amount of spending reductions necessary to immediately balance the budget would wipe out economic growth, therefore, if sustained they would produce a significant self-inflicted national recession. Second, in theory, the Republicans might gain from a short default-large fiscal consolidation deal, but such a deal would not be very likely. A long default would cut against the Republicans. Raising the debt ceiling with little meaningful fiscal consolidation would be perilous, as Republicans would have to defend their fiscal credibility, but that would be a fight they could wage without inflicting harm on the nation. A short default followed by significant fiscal consolidation is not likely, precisely because the Republicans backing such a notion have repeatedly and widely displayed their cards. Hence, the Democrats know that there is a limit to how long they would hold out. As a result, they would not capitulate, and then the Republicans would be faced by a bad choice and an awful one: yield and receive blame for inflicting lasting damage on U.S. credit or persist and receive blame for damaging U.S. credit and engineering a steep recession, possibly of global magnitude.
To push the U.S. acros a line it has never before crossed will, despite the Druckenmiller hypothesis (which is not widely shared), damage U.S. credit. Once a red line is crossed, few would have reason to believe that political leaders might, when things become even more difficult, cross additional red lines. In effect, the psychological barriers that were assumed to exist and preclude U.S. default would be shattered as far as the markets are concerned. Those responsible for the reckless move will bear full accountability for its consequences. Their electoral prospects would very likely be severely damaged. Perceptions of their fitness to govern would be greatly undermined. They would be viewed as the persons who deliberately damaged American credit. All of those consequences would be deserved.
In the end, I do expect an agreement to raise the debt ceiling, because no responsible political leader would be willing to take the default course. I do worry that the deal will come with fiscal consolidation that is on the weak side. That will be a fair battle for the 2012 campaign. It will be far more responsible than pushing the U.S. across a red line into technical default on some of its obligations, even if debt payments are made on time.