US debt deal

By S. Sethuraman

US Congress finally voted to raise the sovereign debt ceiling of 14.3 trillion on August 2, hours before the deadline for the Federal Government to lose its borrowing authority, thereby helping to avert a first-ever default, which would have triggered a financial tsunami across the world. For weeks USA had run the risk of its highest rating being downgraded with calamitous consequences for global currency, equity and commodity markets. The warring factions in divided Washington fought bitterly before striking a compromise involving spending cuts of trillions of dollars in no way balanced with new tax revenues sought by the White House. The entire process was damaging for confidence in USA.

The bipartisan deal offers only mild relief to an economy which almost stalled in the first half of 2011 at around 0.8 per cent and unemployment remained stuck at 9.2 per cent in a faltering post-recession recovery. Though frustrated in his sustained efforts to secure a balanced outcome in the tortuous negotiation between die-hard Republicans and Democrats, President Obama signed the law -Budget Control Act of 2011 – saying it averts a default that would have “devastated our economy”.

He said this compromise guarantees more than $2 trillion in deficit reduction and an important first step “to ensuring that as a nation we live within our means”. He assumes it also “allows us to keep making key investments in things like education and research that lead to new jobs, and assures that we’re not cutting too abruptly while the economy is still fragile”. According to a White House statement, the enacted deal would enable increase the public debt limit by between $2.1 trillion and $2.4 trillion with roughly equivalent limits (cuts) on discretionary spending over the next decade (2012-2021). It established a congressional Joint Select Committee on Deficit Reduction.

President Obama considers the work of this committee as important for the long-term health of the economy and he hopes to take his case for balance on its next stage when the committee considers the second phase of spending cuts, to secure the needed tax revenues and get rid of taxpayer subsidies to oil and gas companies, and tax loopholes that “help billionaires pay a lower tax rate”. Another frustrating battle lies ahead. As the United States teetered on the brink of a debt default, Republicans were not bothered about the state of economy but only determined to scale down the size of Federal Government.

In long-drawn out negotiations, the White House had to yield on some vitals before compromise could be finalized. (The Republican-dominated House voted 269 to 161 to send the law to the Democrat-held Senate where it was approved by 74 to 26 votes with 45 Republicans joining in favour.). Nevertheless, the President considered outcome important in that it “allow us to avoid default and end the crisis that Washington imposed on the rest of America”. The gain, if any, could be that Republicans would not be able to tighten the grip as much holding the President accountable for more cuts at the second stage of raising the debt limit.

Effectively, the debt ceiling would stand raised by over two trillion dollars between now and the end of 2012 – the year when the Presidential and Congressional election campaigns gain momentum. The joint committee of Congress takes up in November the proposal to further reduce the deficit (1.8 trillion dollars), which will then be put before the entire Congress for an up or down vote. The first phase coming into immediate effect provides for, 900 billion dollars of cuts over a decade and it would not be significant in the initial years.

But it is Democrats’ understanding that “everything will be on the table”, meaning tax increases, in the next stage of deliberations. If the Committee fails to reach accord, spending cuts of 1.2 trillion would automatically kick in and the debt limit would rise by this amount. Fissures are inevitable in the months to come as besides the second stage of the deal, the Congress spending authorisations so far cover only the current fiscal year ending September 2011. The fiscal 2012 budget presented in February last by the President, is pending.

Rise in debt limits do not authorize new spending commitments but only helps Government finance existing legal obligations that Congresses and presidents of both parties have made in the past. The Treasury had warned Congress of catastrophic economic consequences from a default, possibly precipitating another financial crisis and threatening the jobs and savings of everyday Americans, at a time of fragile recovery from recession, the earlier fiscal stimulus has run out and payroll tax cut and extended benefits for the unemployed would be expiring at the end of the year. .President Obama has urged Congress, when it returns from August recess, to tackle entitlement and tax reform, extended unemployment benefits and middle-class tax cuts. “Voters may have chosen divided government, but they sure didn’t vote for dysfunctional government,” he said.

The US debt deal has not cheered investors or markets worldwide. Some analysts hope the Congressional committee would revive ambitious debt-reduction goals. Commentators have also seen “strategic failures” on the part of the President in not pushing for debt increase much earlier, instead of close in not pressing for tax code reform proposals of the Fiscal Commission to offset the substantial reduction of debt and deficits it had recommended.

Foreign investors and economic analysts view further action as crucial to restoring the United States’ financial reputation. Unimpressed, the Dow Jones industrial average slumped 264 points by the close of trading after the Senate vote. All the three main indexes of Wall Street were down more than one per cent. Reflecting mixed feelings, rating Agency Moody’s said it would not immediately lower the government’s AAA credit rating, but has not ruled out downgrade unless more was done to deal with deficits.

China, the largest foreign holder of US debt (1.16 trillion dollars), has been highly critical of the “irresponsible brinkmanship” in Washington, and feels the deal agreed is too modest and has not lifted concerns on how the future process would go through. The deadlock was already strangling fragile economic recovery not only in USA but in the world as a whole. China’s Central Bank Governor Zhou Xiaochuan gave a cautious welcome but would watch how the legislation gets implemented through its stages. With reserves already exceeding three trillion dollars, China would continue to diversify its foreign currency investments and strengthen risk management to minimize the impact of the global financial market’s fluctuations on China, a statement of the People’s Bank of China .noted.

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