Worldview: Republicans' stance on debt could have drastic consequences for the U.S.

Posted: June 30, 2011

At a time when America's economy is hurting, Republican presidential hopefuls call for "restoring American greatness."

So why are Republicans in Congress bent on policies that would hasten U.S. decline?

America's strengths - which made it the unchallenged global leader - were based on democratic institutions and economic successes. Other nations sought to copy our economic and political systems because they worked better than any other model. That's what was famously known as our "soft power."

Yet Republican brinkmanship over hiking the U.S. debt limit is endangering those already troubled institutions, and signaling the world they could fail.

Few Americans grasp the dangers of the congressional battle over the debt ceiling. Somewhere between 33 percent and 40 percent of every dollar the U.S. government spends is financed by borrowing. Under Republican and Democratic administrations alike we have been able to finance this debt because U.S. Treasury bills are considered the world's safest investment. Countries such as China and Saudi Arabia keep their excess funds in T-bills because of their unqualified faith in U.S. institutions.

That could change.

The debt ceiling needs to be raised at the latest by early August - not to spend more, but to cover current obligations. Republican and Democratic leaders have been locked in talks to find $2 trillion in federal savings to offset a rise in the debt limit.

Seeing a political opportunity to push for Medicare cuts, Republicans insist the entire amount must come from slashing the federal budget, with no increase in revenue. This wholly unrealistic stance is dictated by politics, not economic reality.

Republicans have rejected Democratic pleas to eliminate some tax breaks, say, for oil and gas companies making windfall profits. House Majority Leader Eric Cantor (R., Va.) even walked out of the talks in a dramatic gesture of displeasure.

From such political posturing, disaster can come.

"Right now investors and other governments are scratching their heads in disbelief. They have a hard time understanding this," I was told by Princeton University economist Alan Blinder, a former vice chairman of the Federal Reserve System's Board of Governors.

"If we actually started defaulting, this would be a big shock to the financial system . . . on a par with, and maybe beyond, the impact of [the collapse of] Lehman Bros." That event triggered the 2008 global financial crisis.

"There is a tremendous concern about what might follow a Greek default," says Blinder, "but Greece is a tiny country compared to the United States, and it has no role in the financial leadership of the world. How much greater would be the impact of . . . the U.S. defaulting."

The mere thought of a U.S. default makes waves.

Republicans claim we would not have to default if we failed to raise the ceiling. But, as President Obama pointed out with visible frustration in a news conference Wednesday, that would present impossible choices. Without new loans, any effort to pay the interest on existing foreign debt would rule out meeting our domestic obligations.

"Are we really going to pay interest on Treasury bills to China," asked the president, "and not pay Social Security checks, or not pay veterans? We're the greatest nation on Earth, and we don't act that way."

If we do act that way, however, world markets will take note.

Global faith in American institutions, already weakened, will tank if we appear ready to default on our financial obligations, including domestic ones. If bond markets begin to think T-bills are the least bit risky, we will have to pay higher interest rates to attract investors. This will make our economic recovery much, much harder.

"This might lead to a situation where the world can't regard the U.S. as a safe haven," says Robert Solow, a Nobel laureate in economics. "This would be a terrible blow to the leadership role of the United States."

Which brings us back to Republican tropes about restoring American greatness. American leadership is already being challenged abroad by China, which is promoting an alternative governance model to ours: state capitalism plus political repression. The Republican flirtation with default plays into Beijing's hands.

"The spectacle of U.S. democracy being so dysfunctional will reinforce the narrative . . . of the rise of state capitalism as an alternative to free-market capitalism," says Sebastian Mallaby, of the Council on Foreign Relations. "It plays into the hands of autocrats in Russia and China who say democracy can't promote growth."

I'd add that this display of U.S. dysfunction also undercuts the appeal of democracy for Arab revolutionaries. Further, it reaffirms radical jihadis' convictions that America is in decline.

So Republicans who say they want to restore American greatness - including tea party hard-liners - should look hard at what they are actually doing. By pushing America toward default, they risk destroying what they claim to admire.


E-mail Trudy Rubin

at trubin@phillynews.com.

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