IMO, some of the comments about the debt ceiling, especially among radio hosts such as Mark Levin (who is openly championing a failure of negotiations), are surreal. The political denial in Washington is also quite surreal.
Major fiscal consolidation is necessary and inevitable. Indeed, one fund manager
argued that a U.S. default is a matter of time.
Increasingly, the only real question is whether the U.S. fiscal consolidation program will be something the U.S. has latitude to shape when market conditions remain relatively benign/interest rates abnormally low or something that will essentially be imposed when a crisis is imminent or underway. The former approach would allow for a transition to mitigate the macroeconomic and social pain. The latter would require wrenching choices and little or no transition. The former could be feasible with smaller sacrifices. The latter would require much larger ones, due to higher interest rates/reduced long-term growth prospects, and prevailing negative psychology. The sooner credible action is undertaken, the less likely a crisis would be. Little or no credible action over the next few years could well provide the invitation to a crisis.
Finally, if I were evaluating U.S. credit risk (and it's probably a good thing that I'm not), I would probably put the U.S. under review for a possible ratings downgrade if no debt ceiling deal is reached in the next 7-10 days. Then, beyond a debt ceiling-modest fiscal consolidation agreement, in order to preserve the AAA rating, I would be looking for progress with respect to two criteria over the next 6-12 months:
1. Construction of a balanced and credible fiscal consolidation strategy, with a credible upfront component. Mandatory spending and Tax Code changes would both be needed for the longer-term. Spending-driven consolidation should, consistent with empirical literature on successful consolidation efforts, exceed revenue measures by a > 2-to-1 margin. Moreover, tax measures should be focused broadly not narrowly.
2. Evidence that the U.S. is undertaking steps to address what is now a political dysfunctionality problem.
Failure to begin laying out a credible fiscal consolidation strategy would leave the nation on its present unsustainable fiscal course. Failure to begin addressing the political dysfunctionality problem would raise questions about the credibility of U.S. fiscal commitments and the capacity to shape/implement/sustain a fiscal consolidation strategy.