The real costs of the debt-limit deal

While the immediate crisis over a threatened default seems to have been averted by the eleventh-hour deal between the White House and Congress, the debt-limit drama has left behind crucial questions about the American political process, the viability of economic policy options and implications for the rest of the world.

The long, tortured debate exposed toxic partisanship and legislative dysfunction in Washington just when judicious efforts at reform were most needed, shaking the faith of international investors and ordinary Americans alike.

The most palpable concern was that gridlock had deprived policymakers of the monetary and fiscal tools they needed to shore up one of the world’s bedrock economies, which some feared was already close to stalling.

“Because of the very public and intense squabbles in D.C., already-anemic economic growth will be weaker, the unemployment crisis will worsen, income and wealth inequality will deteriorate further and, ironically, the fiscal dynamics will be more challenging,” said Mohamed El-Erian, co-chief investment officer of the international bond fund giant Pacific Investment Management Co., or PIMCO.

China, Washington’s largest foreign creditor, has been particularly blunt about other countries’ exposure to Washington’s partisan warfare. “The ugliest part of the saga is that the well-being of many other countries is also in the impact zone when the donkey and the elephant fight,” China’s state-run news agency Xinhua wrote in a commentary, referring to the symbols of the Democratic and Republican parties.

Reuters posed several key questions to dozens of investors, policymakers, strategists and economists to gauge the implications of what the debt ceiling fight means for America and the world. While their judgment was almost uniformly dismissive to dire, their collective judgment was not entirely bleak: Republicans and Democrats were at least united on the fact that America must get its fiscal house in order.

WHAT DOES IT SAY ABOUT AMERICA’S ABILITY TO REMAIN THE WORLD’S SUPERPOWER?

Virtually everyone agreed that America’s fiscal path is unsustainable: With a national debt of more than $14.3 trillion, the U.S. borrows forty cents of every dollar it spends.

Yet there is intense, fundamental disagreement on how to solve the problem, with Tea Party Republicans as passionately opposed to increasing taxes as progressive Democrats are to making deep cuts in the Social Security pension system and other so-called entitlement programs.

In the marginalization of the political center and dismal prospect for expedient reform, experts saw a threat to America’s geopolitical strength.

“It’s hard to maintain your influence globally when you can’t manage your own country,” said Barry Bosworth, a veteran fiscal and monetary policy expert at the Brookings Institution.

The former chair of President Barack Obama‘s Council of Economic Advisers tacitly agreed. “There is no way we can have persistent deficits of the size the Congressional Budget Office is predicting over the next 25 years and hope to remain the world’s preeminent economic superpower,” said Christina Romer, who left the CEA in September 2010. “If we don’t deal with these deficits there is no way we won’t eventually default and become a much weaker country.”

Many Republicans and some Democrats fear that defense cuts could have the same effect. At least $350 billion of the initial $917 billion in spending cuts over 10 years are to come from defense and other security programs, which now account for more than half of discretionary spending.

The Pentagon budget for fiscal year 2010 was $680 billion, a reminder of the vast size and reach of America’s global military power.

Many, including Pentagon experts, worried that another $500 billion of cuts over the next decade, which could be triggered by a failure of the second phase of the compromise plan, would gravely undercut the United States’ international influence and its ability to execute a muscular foreign policy.

Pressure on the dollar as the world’s reserve currency would also have geopolitical repercussions.

In the short-term, the United States’ and the dollar’s world standing is safe, because no other country is able or willing to take its place. Europe’s own deep crisis with indebted nations such as Greece, Ireland and Portugal means that the euro is not quite the stable bet it once seemed to be, and China has no clear alternative to buying U.S. bonds to prevent its huge trade surplus from driving up the value of its tightly managed yuan.

But China’s economy is rapidly shifting, and its need for reserves of Treasury debt will shrink, according to Stephen Roach, a senior lecturer at Yale University and non-executive chairman of Morgan Stanley.

Beijing’s latest five-year economic plan focuses on building up domestic consumption, and China could even post a current account deficit by 2015, Roach said – meaning it would no longer need to buy as much debt. “They are moving away from the dollar whether we like it or not,” he said.

If the dollar lost its status as the world’s reserve currency it would do more than undercut America’s geopolitical position: It would drive up interest rates and borrowing costs for the government, businesses and households.

PIMCO’s El-Erian described the debt-limit battle as a “self-inflicted wound that weakens the economy and erodes its standing globally.”

John Steele Gordon, a financial historian, downplayed the immediate effect of the debt-ceiling fight. “I don’t think it will change the U.S.’s superpower status to any degree. We’ve had these knock down fights before.”

Yet he too saw the government’s budget deficit as make-or-break for America’s place in the world: “What will affect superpower status is if the U.S. continues to spend more money than it takes in.”

HOW MUCH DOES THE DEBT DEAL FIX THE U.S. FISCAL CRISIS?

There is no way to curb soaring U.S. debt without confronting three of the biggest drivers of American spending: Social Security, Medicaid and Medicare. Deep cuts in any of them represent deal-breakers to large and powerful political forces.

Left unreformed, these three programs – the federal pension system and the programs that support health care for the poor and the elderly – would devour every cent of America’s tax revenues by 2047, according to the non-partisan Government Accountability Office.

Yet even with the threat of a catastrophic default as an incentive, and agreement by both parties that deficits must be brought under control, the debt-limit deal that finally emerged still failed to include robust reform of what are described as “entitlements”.

The failure is symptomatic: Every important economic lever must work against a big political stick in the gears.

With more government stimulus “off the table,” the slow-growing economy cannot generate enough jobs to pull down the unemployment rate. That in turn means Washington has to spend even more than expected on unemployment benefits, food stamps, Medicaid and other programs. Cuts in those programs would then become even more painful.

With tax hikes likewise “off the table,” tax revenues will be restrained by weak consumer spending and idled labor.

And so on.

As a result, PIMCO’s El-Erian expected the debt-ceiling compromise to do “very little, if at all” to fix America’s underlying fiscal crisis. “Remember a sovereign debt burden is defined as total liabilities relative to a country’s ability to service them. So it is not just about the debt stock, the maturity profiles and interest rates. It is also critically about the ability to grow. And this crisis has undermined growth, investment and employment.”

Romer said “a holding pattern” is the most likely outcome of the debt debate saga. “It deals with the immediate issue of the debt ceiling but doesn’t face up to our long-term deficit problem.”

Morgan Stanley’s Roach put it bluntly: “Make no mistake, we are not getting a major breakthrough in America’s fiscal dilemma out of this deal. Talk about kicking the can down the road – this is probably the biggest can that’s ever been kicked.”

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8 Responses to "The real costs of the debt-limit deal"

  1. Carl Nemo  August 2, 2011 at 9:31 pm

    “It’s hard to maintain your influence globally when you can’t manage your own country,” said Barry Bosworth, a veteran fiscal and monetary policy expert at the Brookings Institution. …extract from article

    Why is it the people that are elected to both represent and manage this natiion on our behalf are so obsessed with maintaining global influence?

    They’ve worked feverisly on the homefront since the mid-90’s to destroy America’s manufacturing infrastructure turning us into a nation that’s virtually dependent on offshore producers for the vast majority of our consumer goods. So too they let the deep pockets sector of our society off the hook concerning them paying their fair share of taxes or avoiding them completely via the off-shoring of their ‘storefronts’ via a simple mailbox housed in the Cayman islands, “1900” of them at last count.

    These power obsessed, overly-educated bureaucrats seemingly cannot connect the dots between jobs and the income taxes derived thereof as allowing them to continue their failing quest to achieve ‘Empire Americanus’ with a peace dividend such as the Romans enjoyed during their two hundred year period known as “Pax Romana”.

    Seemingly Roman emperors were savvy enough to rein in their conquest mad generals in order enjoy a relative peaceful era within their national history; I.E., a true “peace dividend” as a function of many years of intense empire building. They decided to give it a rest for the benefit of the empire and its citizens.

    http://en.wikipedia.org/wiki/Pax_Romana

    Instead our leadership, particularly the Republicans driven by an obviously failed PNAC driven manifesto have broken the very nation they had hoped to achieve such a peace throughout the world. We’re both a broke and broken debtor nation suffering a destroyed job and tax base.

    To get back on our feet would take a domestic plan to rebuild our national infrastructure and expunge the word “globalisam” from public discourse; I.E., a word and concept worthy of capital punishment.

    This nation is dying the death of a thousand cuts at the hands of faceless, overpaid bureaucrats who enjoy enforcing the letter of their obviously flawed and in many cases corrupt laws to the nth degree regardless of the terminal damage being wrought upon this nation.

    A host organism, the U.S. is being destroyed by bureaucratic parasites, all overpaid and seemingly without a clue as to why they are soon to lose their source of ‘nourishment’ ; I.E., , a paycheck too, like the unwashed masses they’ve managed to destroy in less than two decades.

    Carl Nemo **==

    • b mcclellan  August 2, 2011 at 10:05 pm

      ekirtsacirema.

      • b mcclellan  August 2, 2011 at 10:14 pm

        Hold on to your hat.
        Pop said , when in doubt weed the garden.

        • Carl Nemo  August 2, 2011 at 10:20 pm

          Your pop was right and seemingly we have so many weeds at the top that it will take an engineered version of “Roundup” that’s politician and faceless bureaucrat effective…no? : |

          Carl Nemo **==

          • woody188  August 2, 2011 at 11:36 pm

            Haha, those politicos are all “Roundup Ready” for sure!

            I hate GM crops.

  2. woody188  August 2, 2011 at 11:35 pm

    I see Wall Street wasted no time in pushing a huge sell off as soon as the deal was passed by the House. Ah sweet reality…

    • Carl Nemo  August 2, 2011 at 11:56 pm

      I suspected this ‘engineered bust’ too Woody. I’m thinking of all the hedge funds that pumped the various sectors sky high, specifically gold, silver and FOREX then pulled the plug on the gullible, uninformed, very fearful investors that pitched their hard-earned bucks into the fray, hoping to save their butts from this lengthy, protracted airing of political high theater, all to their financial detriment.

      They, the usurpers, are playing us all in every way…every day…! / : |

      Carl Nemo **==

  3. kishind  August 4, 2011 at 6:59 pm

    This entire fabricated crisis has clearly demonstrated some of our most severe political problems. First, Grover Norquist and his followers (Republican politicians) have decided with absolute certainty that it would be better to financially ruin America, even driving it into default!, than to increase tax revenues ever for any reason. This, despite the fact that the Bush tax cuts are the biggest single policy contributer to the annual deficit. This, despite the fact that they claim to be the party of financial responsibility, although this facade is quickly slipping away.

    Because Republicans vote uniformly and Democrats suffer from independent thought and a missing spine, Republicans have disproportionate leverage in Washington. When they want something, they play a game of political Chicken and would rather die in the collision than turn the wheel. This is the power of absolute commitment – and it has no place in governance.

    So let’s ignore the sound fiscal policy of Clinton’s tax rates for now… in fact, let’s ignore all potential increased revenue, since the Republicans have no taste for it. Federal spending is a pie with five pieces: SSI, Medicare&Medicaid, “Defense” (aka War), Discretionary, and Other.
    1. “Other” includes crowd-pleasers like education and roads, environmental spending, and interest on our national debt. Any cuts here would be minimal. Most of these things are mandatory for the continuing well-being of our nation.
    2. Social Security taxes are already bringing in more revenue than SSI is spending. The most reasonable change is to make the SSI collection age equal to our national life expectancy, as it was when it social security was first created.
    3. Medicare/Medicaid is the halfway point of socialized health care. Medical costs in this country are absolutely astounding. For low income households, just an ambulance ride is roughly equal to a month’s rent. A single life-saving surgery can exceed an entire year’s gross income. Cancer treatments can mean bankruptcy even in middle-class households. In the meantime, pharmaceutical and medical supplies companies are delivering record profits. To me, the only logical approach is to attempt to lower all medical costs in this country, through which government spending on public medicine would be reduced. Universal health care, although expensive in the short term, would ultimately reduce the country’s medical costs, but it won’t change the fact that government provisions for the elderly are insanely expensive and a drain on the future. And yet denying medical care to the elderly just doesn’t seem right. Since the obvious solutions are not appealing, we need an innovative one.
    4. “Defense”, our country’s war budget, is out of control. USA spends more than any other country on war (we’re #1!). In fact, if you add up the war budgets of #2 (China) all the way through #18 (UAE), America still exceeds it. We spend 4.7% of our GDP, typical of more aggressive nations… places like Canada and the Netherlands spend a modest 1.5%. No doubt, we have the coolest murder toys. And I agree with the timeless saying “if you want peace, prepare for war” – but if you want peace, don’t prepare for world conquest. We could slash the defense budget in half and still be ahead of every other nation (militarily) for a long, long time. Terrorism is NOT a war. It’s a worldwide criminal pandemic. Its participants are not “non-government soldiers” or “enemy combatants”, they are international criminals, and should be treated as such. I was never in favor of our country’s two current wars of aggression. It’s as ridiculous as Canada invading the Untied States because we were “harboring” Al Capone. I am in favor of immediate withdrawal of the majority of troops… we were never planning to leave entirely, and will likely leave a military base in both Iraq and Afghanistan for as long as the United States exists. But we should get as close as we were ever going to get to having zero troops in these two countries, and stick to Reagan-era illegal overthrows (threats of assassination, monetary funding for violent rebel elements, that sort of thing). (Dreamily) oh Reagan/North, you high-treasonous jerks… Obama indicated a return to this policy, by publicly sponsoring the violent, fanatical elements in Egypt in their jihadist struggle against Mubarak. “Protesters” don’t blow up/burn down jails, hospitals, libraries, private residences, and Egypt’s National Council for Women. Praying in the street in military formation is not a form of protest, it’s a practice of jihad. In essence, starve our military budget, but not our military people.
    5. Discretionary spending – also contains programs for the social safety net, like subsidized housing. Any congressman who is serious about fiscal responsibility should agree to reduce their salary by half (from 170k/year to 85k/year). It’s generally not their only source of income, so it would be more of a symbolic gesture. Discretionary spending is multifaceted, but reasonable cuts across the board would be ideal.

    Still not enough. Screw the Clinton tax rates, let’s move to FairTax(.org) and tax only spending. That way, Bill Gates won’t be taxed below the poverty level just because Microsoft had a bad year. Unreported incomes (largely immigrant) would begin to pay taxes. Tourists would be solid contributers to our taxes. Wealth hoarders would lose their ability to have a lower tax rate than nurses and teachers. Tax revenue and public consumption would be one and the same.

    Still not enough. How about we legalize, regulate, and tax all illegal drugs. That would pull a $300+ billion/year industry out of criminal hands – and cut the multi-billion dollar programs known as the “war on drugs”. We as a country could stop financing the Mexican mafia to support our weed habit. The prohibition provided vast income for organized crime almost 100 years ago, and modern prohibition is no different. Denying legal trade of goods and services that are in demand is precisely equal to funding organized criminals. The War on Drugs is actively supporting its supposed enemy, resulting in conflicts that never should have existed in the first place.

    Still not enough?

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