Since the Republican Party took over the U.S. House of Representatives in 2010, its battles with the Obama administration have taken on Wagnerian levels of grandiosity. Increasingly, the current political showdown over the federal budget and the debt ceiling looks less like a domestic policy disagreement and more like a militarized dispute between two enduring rivals in world politics. Both sides say they want a deal that raises the debt ceiling and funds the federal government – but their behavior suggests that they’re willing to risk a protracted conflict to get what they want. At this point, both Republicans and Democrats seem to care more about politically crippling the other party than they do about promoting the general welfare of the United States.
Over the past few weeks, both sides have articulated their tactics and strategies. Looking at their strategies to date, however, this international relations theorist reaches a disturbing conclusion: President Barack Obama seems far too clever for his own good, while the Republicans might just be stupid enough to claim victory.
Let’s start with the president. As a general rule, sitting American presidents don’t talk down the economy — but last week, Obama made an unusual exception. In an interview with CNBC, he said, “This time I think Wall Street should be concerned,” concluding that “when you have a situation in which a faction is willing to default on U.S. obligations, then we are in trouble.” It is certainly true that both public sector and numerous private sector analysts have warned about the calamitous consequences of a debt default (though not everyone is convinced). Although Obama was breaking with tradition, the president’s logic for trying to scare financial markets seems pretty clear. If markets start to panic, then both Wall Street and Main Street will start to pressure the GOP caucus in the House to acquiesce to what Obama wants: a clean debt-ceiling increase. In essence, the president wants the stock market to impose economic sanction on the Republican Party.
There are past examples of financial-market gyrations forcing politicians to do something they otherwise would not have. As the 2008 financial crisis started to snowball, Congress tried to pass the Troubled Asset Relief Program (TARP), only for it to founder in the House of Representatives. Expecting passage, markets were surprised: The Dow Jones industrial average experienced its largest single-day loss in history. The S&P 500 and Nasdaq both lost approximately 9 percent of their value. A week later, the House passed a revised TARP bill. A similar dynamic played out during the episode that most closely mirrors the current deadlock — the 2011 showdown over the debt ceiling.
It would seem that this is the sort of dynamic Obama wants to see play out. But there are two things getting in the way of the president’s “panic Wall Street” strategy: theory and practice.
Despite the president’s warnings, financial markets have not panicked so far. Part of the problem comes with the fact that traders don’t make money by acting as Obama’s messenger. In theory, Congress yields after markets tank — when Congress acquiesces, markets rebound. But in a world that assumes traders possess rational expectations, there is not much individual incentive for them to heed Obama’s advice. No matter how a trader hedges the bet, Obama is in essence asking investors to bet on markets going down when, if the strategy works, they will not stay down. That’s not a great bet for traders to make. As Neil Irwin, a Washington Post economics columnist, has pointed out, “you don’t become a hotshot hedge fund trader by making bets based on what ‘ought’ to happen or what seems to make sense on some academic level. You only make money if you guess the direction of markets correctly. And if this standoff ends not with a bang but a whimper . . . then the current prices in asset markets will look about right.”