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Making Sense of the Debt Ceiling Crisis

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For months now, Washington and the world's financial markets have been focused on whether and how the American debt ceiling crisis can be resolved. The debate today is not principally over the economics - all but a very few believe that America needs to get hold of its spending and bring down the deficits and the debt. The problem is in the politics.

At a fundamental level, this is about basic ideological beliefs about how money should be distributed. The Republicans believe that if you earn your money, you should get to keep most of it; taxes should be low and government limited. Democrats believe that there is a responsibility to ensure a strong social safety net for everyone and for that the government needs resources. Complicating these two positions are differing perceptions of how best to inject momentum into the economy and create jobs.

Clearly the right position is a balance between these two, but where that balance lies is less certain.

There are not two, but three groups negotiating in Washington: the Democrats, the mainstream Republicans, and the Tea Partiers. The first two groups are engaging in the debate with some posturing but with an eye to finding a compromise solution that can be accepted by most. The last group, unfortunately, is not. They are taking their position of fiscal austerity to the extreme, as the "Cap, Cut and Balance" bill that went to the House last week indicates. In taking such a strong and inflexible position they are closing the negotiation space for the moderate Republicans who have to choose between finding a solution to one of the most important challenges facing the United States today and splitting the party.

Given the imminent deadline of August 2, it is unlikely that the "Grand Bargain" that is so important to America's long term economic stability will be found, at least immediately. On the other hand, the cost both economically and politically of not raising the debt ceiling is so great that the politicians are likely to find at least an interim solution. While President Obama has said he will veto a short-term proposal requiring another round of major negotiations before next year's elections, it is quite possible that a solution allowing for an extension of the ceiling for a short period (up to a month) will be found to permit a broader and longer term proposal to be forwarded to Congress.

In order to achieve this solution, the two groups that are going to have to come together are the two who are willing to compromise. Thus the only viable solution will mean a split in the Republican party. While this divide is only likely to last as long as the vote in Congress, it could in the coming months presage a longer and more durable split in the party as the election season approaches.

With a few exceptions among the Tea Partiers, all parties know that a default would have major implications not just for the United States and its economy (and the finances of American voters) but for the global market. But this should not be over-emphasized. At a fundamental level, America and the dollar will continue to be a sound investment over the long-term. More concerning perhaps will be the perception - inaccurate as it might be - that the American political system really is broken.