As the game of brinkmanship over the U.S. debt ceiling enters the final period, there is optimism that a short-term fix is possible. Although financial markets have remained remarkably composed, as the game clock runs down further without a resolution, look for greater volatility.
Markets may have been remarkably blasse, in part at least, because of a shared sense of disbelief: rational actors would not, investors might have thought, jeopardize the U.S. recovery and global financial stability; "saner heads will prevail," they assumed,"and a compromise will eventually be negotiated." Perhaps.
Similar thinking undoubtedly prevailed in July 1914, as country after country mobilized in a Tuchmanian "March of Folly." But rational actors did go to war then. Perhaps this was the result of some miscalculation, or perhaps it was a concious decision to fulfil some misguided geopolitical strategy.
Regardless, history is replete with examples of supposedly rational actors doing, in hindsight, irrational acts. Frequently, these outcomes reflect miscalculations in a game of brinkmanship.
Brinkmanship entails one player threatening the other player with a very bad outcome (e.g., debt default and financial armagedon), in conjunction with a series of "concessions" that would avoid the cliff. At each round of the game, the asymmetry between the consequences of threat and the cost of the concession induces the other side to yield. Once the other side has accepted one concession, however, the threat of going over the brink is invoked again to secure the next. And when that too is accepted, the threat is used again; and so on until the other player has been forced to concede to the other player.
But brinkmanship "works" because there is an element of uncertainty — the risk of miscalculation. Absent this possibility, the threat would not be credible since the consequences of going over the brink affect both sides. To some extent, the strategy works because the outcome of the game is put in the hands of fate. The problem is that, because brinkmanship requires a credible threat of truly dreadful outcome to be effective, such miscalculations on the opponent's willingness to concede lead to tragic consequences.
So, how do we interpret the game of brinkmanship over the debt ceiling?
To begin, it is unclear what series of small concessions might be on offer to remove the threat of going over the brink. Obamacare, which is at the centre of the impasse, is the President's key "legacy project." A small concession now merely exposes his plan to a death by a thousand cuts. From the President's perspective, therefore, the required degree of asymmetry between a debt default and defunding Obamacare just isn't there; particularly if the game of brinkmanship erodes support for those employing brinkmanship, who might themselves be forced to concede.
At the same time, an effective defence to brinkmanship would reduce the consequences of the threat. This has surely been the focus of attention in recent weeks; indeed, months, knowing that this problem would arise once again.
There are two options here. The first is to simply ignore the debt ceiling, arguing that the constitution obliges the Executive Branch to avoid a default in order to preserve the full faith and credit of the U.S. government. The argument would be that that constitutional requirement and the President's peroragatives to act in exigent circumstances supercede the debt ceiling limit, especially as a higher ceiling is required to fund programs that Congress itself has approved! Under this scenario, Treasury would merely proceed with regularly-scheduled auction of Treasuries in order to avoid default.
The second option is somewhat more daring. The debt ceiling limit applies to the issuance of Treasury securities. It does not apply to coinage. As Paul Krugman has been arguing for some time, the President could authorize the minting of a very, very large denomination coin (think: a trillion dollars) which would be deposited at the Fed. This would avoid the risk of default and, since the Fed has been holding vast amounts of Treasuries ever since the disruption of the Lehman failure, would not represent a significant departure from the status quo.
These options could not, however, be mobilized proactively. As exigent measures, they would have to be invoked in response to the clear and present danger of a national emergency. The unfortunate result is that, even if mobilized immediately, they do not preclude the possibility of large negative shocks ahead.
In this respect, the best prospect for avoiding such disruption rests with the voters in key congressional districts telling their representatives to stop the gaming and start governing or face the consequences in the mid-term elections. This outcome would be a vindication to American democracy at a time when foreign attention is focused on its presumptive dysfunction.