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Magazine / NEED TO KNOW: COVER STORY—ECONOMY

Uncertainty Unleashed

Washington’s debt-limit collision is already radioactive for the recovery.

Lost: Instead of combating uncertainty, Washington amplified it.(Ramin Talaie/Getty Images)

photo of Jim Tankersley
July 28, 2011

One of the tenets of quantum mechanics is Heisenberg’s “uncertainty principle.” It goes like this: If you’re watching an electron race around an atom, you can pinpoint how fast the electron is going, or exactly where it is, but you can’t do both. The more you learn about one, the less you know about the other. Thirty years after Werner Heisenberg died, Washington is illustrating a political variant of his theory in its brinksmanship over the debt ceiling. Hoping to increase “certainty’’ about the government’s long-term borrowing and tax rates, lawmakers have accelerated their showdown over spending cuts. In the process, however, they’ve reduced certainty by introducing a once-unthinkable question: Can the United States be trusted as the bedrock of the global financial system?

By bickering over the debt limit, lawmakers have forced investors, consumers, and job creators to seriously entertain the possibility that Congress will let the U.S. government default on its debts, lose its perfect credit rating, and stop sending checks owed to soldiers, hospitals, retirees, and others. Economists predict the damage from that—fear that the political system cannot carry out basic responsibilities—will linger even if Washington cooks up a last-second compromise.

This week, economists at Nomura Securities calculated that a ratings-agency downgrade of U.S. debt could reduce gross domestic product growth by as much as 0.8 percent over the next year and a half, leaving the unemployment rate a half-point higher than it would have been. But that wouldn’t be the worst of it. “The uncertainty surrounding the debt-ceiling impasse,” the economists wrote, “may ultimately prove to have been more damaging than a downgrade itself.”

 

It’s ironic. For more than a year, Republican lawmakers and candidates have blamed “uncertainty,” as opposed to a lack of consumer demand, for sluggish growth and job creation. (President Obama has recently embraced that argument, too.) The core of that argument was that businesses were scared to expand and hire because they were worried about higher taxes and stifling government regulation. The leading uncertainty drivers, the politicians and business lobbyists said, would be health care costs under the Affordable Care Act; restrictions on capital markets under Dodd-Frank financial regulation; and, most of all, fast-rising debt that could trigger a negative reaction from bondholders, higher interest rates and, perhaps, massive tax increases.

Republicans saw the debt-ceiling deadline as an opportunity to ease some of that uncertainty by forcing Democrats to accept big cuts in spending and begin reducing the federal debt. But the negotiations have instead conjured up nightmarish possibilities that had always been unthinkable: an American default; a credit downgrade; and a massive, immediate interruption in government spending. For the first time, investors were forced to contemplate where they would turn if the safest of safe harbors suddenly wasn’t. “U.S. debt is the epitome of riskless debt,” Martin Regalia, chief economist for the U.S. Chamber of Commerce, said in a recent interview. “You’re looking at the asset that is the linchpin of the entire international financial system.” To undermine it, he added, “would be a calamity.”

Economic indicators are already showing hints of calamity to come, regardless of how the debt debate is resolved—or isn’t—in the coming week. Goldman Sachs researchers concluded earlier this month from polling that anxiety about the impasse was likely depressing consumer confidence and spending; the analysts said that most of the damage would likely heal once the ceiling is raised, but not all of it. The VIX Index, which measures volatility in equity markets, is up sharply from mid-July—a show of nervousness that Troy Davig, senior U.S. economist for Barclays Capital, attributes to the debt-ceiling showdown.

Davig published a research note earlier this month that detailed how the discord sowed by fierce debt-ceiling negotiations in 1995-96, when Republicans ran Congress and Bill Clinton was president, hurt job growth for months. The U.S. economy was booming at the time, fortunately. Now we’re not so lucky.

High energy costs, global supply disruptions from natural disasters, and a series of other economic shocks have slowed U.S. growth nearly to stall speed, and employers are sitting on their hands. Are employers now supposed to worry about whether Washington lawmakers can agree to let the government pay its bills on time? If Congress only raises the ceiling to allow for a few more months of borrowing and sets the stage for a repeat battle this winter, do lawmakers really expect anyone to feel confident enough to create a job between now and then?

“It’s adding to uncertainty in a really reckless way. This is a huge weight,” Davig said in an interview. If you were a company watching the drama play out, he added, “why would you be aggressively expanding payrolls in this environment?”

You don’t need quantum physics to know the answer: You wouldn’t. That’s the price of hurtling toward a lawmaker-made financial catastrophe, whether you find the brakes in time or not.

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