American politicians agree: Borrow more. Just don’t raise the borrowing limit

Why is the US economy so determined to ignore the fiscal cliff?

Today’s job’s numbers, while filled with the subtle weaknesses that indicate an economy still on the road to recovery, outstripped expectations. Housing construction and prices are growing, as is consumer confidence and business activity in the services sector. Markets remain blithe in the face of Washington’s political theater, confident of a deal.

Not all is rosy, of course: Business investment is down, which analysts are blaming on the fiscal cliff (we had better hope so), and industrial production shrank last month, according to one index, although another says it expanded. But this isn’t an economy on the brink of recession; it’s an economy that hasn’t reached full capacity yet.

Except that it is—as everyone knows, the fiscal cliff could lead us into a Greek-style austerity recession. But it’s important to understand that the United States does not face a fiscal crisis, and the fiscal cliff is not really about debt reduction. There’s no near-term problem financing government debt. There’s no medium-term problem financing government debt. There’s a lot of debt, yes, driven by long-term health care spending and a disinterest in financing it, but not much evidence it’s hurting private investment, thanks to the Federal Reserve.

The fiscal cliff, after all, is a very effective debt reduction policy: If Congress did nothing at all, the US would immediately be on a path to lower debt. So why is every single debt reduction advocate, from the constellation of organizations funded by private equity banker Pete Peterson to Congress’ leading deficit hawks, against the fiscal cliff? Charitably, they all understand that the economic costs of debt reduction (immediate recession) outweigh the benefits (a more sustainable budget decades from now). There are also suggestions that preaching deficit reduction is a good way to argue for the economic policy of your choice: lower taxes or more spending on social programs.

The real goal of the fiscal cliff talks is figuring out how to increase the debt, to clean up the mess created by 2011′s political showdown over the America’s debt limit. The US, unlike most countries, has separate processes for setting tax and spending policy and for issuing enough debt to make up for the shortfall. Congress sets the ceiling for issuing debt; while it usually raises the limit when necessitated by deficit spending, the ceiling occasionally becomes a tool for fiscal brinksmanship between Congress and the president. If the legislature won’t raise the limit, the eventual result would be a catastrophic default of US debt. (There may be creative ways to avoid such a result, my favorite being the Platinum Coin strategy.)

In 2011, Speaker of the House John Boehner threatened a default on US debt unless his budget demands were met—though the Republican budget, as well as President Obama’s, required increasing the debt limit. The ensuing legislative morass resulted in a set of spending cuts alongside tough caps on future spending and the creation of the fiscal cliff, a legislative time bomb to force through even more austerity if Congress and the president didn’t agree on a different fiscal course.

That brings us to today: Obama and Boehner are negotiating an increase in the federal debt, with their parties in agreement that maintaining middle income tax cuts is a good way to do it. The dispute is how much the US should be borrowing to finance tax cuts for the wealthy (a lot, say Republicans) versus how much the US should be borrowing to finance health care for the elderly (a lot, say Democrats). In the background, there is the question of how much the US should be borrowing to finance its bloated defense budget, also set to be slashed.

The big wrinkle now is that even though both parties are agreed on the need to borrow more money, that pesky debt ceiling is set to be reached once again.

“We have the potential for a much scarier showdown on the debt limit, with potentially much larger damage to the economy, than from the fiscal cliff,” says Robert Greenstein, who directs the Center on Budget and Policy Priorities.

Democrats are insisting that the debt limit increase be included in the deal to avert the fiscal cliff, since both parties agree on the need to increase the debt. Republicans suggest once again they are willing to default, hoping to gain the upper hand in negotiations that have significantly favored Obama since the election.

The scary thing is that going over the fiscal cliff, while likely to rattle markets, shouldn’t result in serious economic damage if a deal is reached is the weeks after to undo its effects. But a potential default on US debt would be very ugly, indeed, and much harder to recover from. How ironic if an economy that’s financially secure were to default thanks to a botched attempt at sustainability.