Weekly Standard Online
July 29, 2011
by Irwin Stelzer
As of this writing, the president has pulled off a great political trick, with the help of some kamikaze Republicans. He has refused to offer a deficit-reduction plan, or submit a budget, or allow the Senate Democrats to do either—and has the public persuaded that he is the man who is seeking a bipartisan solution to the deficit problem. He has also quite cunningly left the Republicans bargaining with themselves—offering progressively greater compromises, but not with him, with their own last offer.
During the so-called negotiations—can you hear the sound of one party negotiating?—we have at least learned one thing: the battle of the deficit bulge in the government finances is both more and less scary than is commonly believed. Start with the less. The only significance of the August 2 date on which the president and Treasury Secretary Tim Geithner say America will be unable to pay its bills is that Congress would like to adjourn next week. The sky-is-falling date has now been pushed ahead by some ten days to two weeks. Even then, the government can manage the flow of payments so that default on the debt is postponed for a considerable time. Geithner will have over $170 billion in revenues in August from which to draw the $29 billion he needs by mid-month to meet the nation's debt interest obligations. America is not Greece: we can pay our bills, roll over IOUs within the debt ceiling, and send out plenty of checks.
The current battle over how to get past the debt ceiling is also less relevant to the ability of the U.S. to maintain its triple-A rating than many imagine. Mohamed El-Erian, CEO of Pimco, the world's largest bond investor, thinks a down-rating is a real risk, and my best Washington sources tell me it is "a 100 percent certainty." The rating agencies have their eye not on this month, or even this year, but on the longer term—whether the nation's politicians can devise a credible medium- and long-term plan for reducing future deficits by about $4 trillion over the next decade, something that does not seem likely unless this weekend's talks are far more productive than we have any right to expect. Even if the warring parties and the factions within the parties can come to some kick-the-can-down-the-the-road compromise, absent some last-minute long-term deficit reduction deal, America's debt will be downgraded. And no such deal seems within the grasp of the political establishment.
If the agencies do downgrade U.S. debt, it is not clear that such a move will have the scary consequences that seem to be the consensus prediction. Our IOUs will remain the safest in the world, and many analysts are predicting that a downgrade would cause anxious investors to flee equities and pile into the safest investment available—despite the downgrade, U.S. government securities. That would prevent the much-feared rise in interest rates here, just as it did in Japan, where a downgrade was followed by a rise in bond prices (a fall in interest rates). The Chinese, holding over $1 trillion of our IOUs, might complain, but they are in no position to dump their massive holding of Treasuries—and do what with the money?—unless they are willing to drive down the value of their remaining holdings. Besides, if they drive up U.S. interest rates, they will stifle American demand for the products of their factories, and make it difficult for the regime to provide the jobs needed to keep social unrest on its current low boil rather than heating up to Middle Eastern levels. At worst, analysts are guessing that interest rates on U.S. debt might rise by between 0.10-0.70 percentage points.
So much for the less scary part. Now for the more scary. Many businesses fear a Lehman-style reaction to a downgrade, with the market for short-term corporate debt seizing up. So they are retightening the purse strings that they had only recently begun to loosen a bit. If cash is to be king, even for a short while, corporate executives intend to pay it court. "This debt imbroglio is just giving companies another excuse not to do much," Joseph LaVorgana, chief U.S. economist at Deutsche Bank told the press. Money market funds, battered after the Lehman Brothers collapse, are also shedding risk and acquiring cash to be in a position to meet redemption demands should those demands skyrocket in the face of a default. Throw in the fact that higher rates on treasuries would surely mean higher interest rates on credit cards and mortgages, and you have a damper on consumer spending that would further slow the economic recovery, which managed only a 1.3 percent growth rate in the last quarter, and has the unemployment rate stuck at 9.2 percent.
Perhaps the scariest aspect of the current crisis is what it tells us about the state of political debate in America. The dollars involved are merely the proxies for the real issue: the role of government in our country in the 21th century.
President Obama and the Democrats believe that the role of the government must be increased even beyond the expanded level to which the president's "transformative" agenda has brought it. They see an ageing population increasingly in need of government care, and a nation in need of a massive upgrading of its infrastructure. If that means higher taxes, so be it: hit what the president publicly calls "the millionaires and billionaires," although he really means families earning more than $250,000 per year.
The Republicans see things differently. The country is reduced to rattling its begging bowl in China and elsewhere to pay for programs that become ever more costly as the president expands the reach of government. The productivity of the private sector is steadily eroded by regulations that give no weight to the need to create wealth and jobs, and taxes that sap initiative and risk-taking. So deregulate, cut taxes to stimulate growth, rein in spending, and reduce unemployment.
There's more, but you get the idea. So far, the electorate has been of little help. A majority of Americans want spending and taxes cut, but their benefits left untouched. In the absence of the sort of leadership that Franklin D. Roosevelt, a Democratic icon, exerted to persuade Americans to provide aid to Britain in the early days of WWII, and that Ronald Reagan, a Republican icon, provided to bring down the Soviet Union, the electorate flounders. In 2012 the electorate will, it is hoped, provide the political class with a bit of guidance as to whether Americans want to follow Obama and continue to transform America into a European-style social democratic state, or choose a leader who will take it in a more historically American direction, with greater emphasis on the private sector and individual initiative.
To the "this-is-scarier-than-it-seems" side of the ledger add the possible cost of uncertainty. One minute we have a deal, the next we don't makes businessmen rethink expansion plans. Add the uncertainty provided by the lesson of Lehman Brothers: the consequences of a financial mishap are often greater and more far-reaching than anyone predicts. Just ask Hank Paulson. With both the U.S. and the euroland countries struggling to pay their debts, the global financial system might just be too fragile to withstand another shock.
I lean to the less scary scenario, but with considerable uncertainty.
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for the Hudson Institute. He is also the U.S. economist and political columnist for The Sunday Times (London) and The Courier Mail (Australia), a columnist for The New York Post, and an honorary fellow of the Centre for Socio-Legal Studies for Wolfson College at Oxford University. He is the founder and former president of National Economic Research Associates and a consultant to several U.S. and United Kingdom industries on a variety of commercial and policy issues. He has a doctorate in economics from Cornell University and has taught at institutions such as Cornell, the University of Connecticut, New York University, and Nuffield College, Oxford.
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