Skip to content

USA gridlocks its way to the brink of default

by Aaron McCormack on July 19, 2011

Everyone will be a loser if the US defaults

As the US debt crisis debate rumbles on, I am struck by the simplistic narratives being peddled, and the devotion to the process rather than the substance that we are getting in the media.  We have talked about the competing Left/Right narrative in the USA before and did forecast this impending “national debate” since the turn of the year.

Now that the crunch moment has arrived, the quality of the debate about the balance between “cuts” and “tax increases” has been very, very disappointing.

We should begin with a quick recap of the problem faced and of the two main narratives for solving the problem – this is for those who have not been following this closely (which is just fine, by the way, as this is most certainly a first-world problem and not as critical  as the Arab Spring or the terrible conditions in the Horn of Africa).

Going back to basics,  it has to be pointed out that debt IN AND OF ITSELF is not bad for a country.  Unless you are mineral or oil rich like Norway or Saudi Arabia, most countries would significantly impede their progress by not taking on debt.  Imagine if you never, ever had to pay the cost of your house, only the interest on the loan – you would be living in a bigger, better house, right?  If you didn’t take the opportunity to do this, people would think you were nuts.  However, there would be a point where the interest payments alone would be more than you can afford.  It would not make sense to borrow too much, even if you never have to repay the principal.  And, as with people, the circumstances of countries can change and we do have to be mindful that just because we can afford to pay today, that does not guarantee that we can pay tomorrow.  Which is why the people who lend the money to people and to countries use credit ratings and charge different rates of interest to different people/countries.

Countries, unlike people, should never have to pay back the principal, only the interest.  (Technically they do have to renew the loans at the end of each loan or bond term, but these renewals under normal circumstances are fairly simple.)  Countries have to carefully judge how much interest they need to pay as a proportion of their expenditure and economists have many guidelines as to how much borrowing is optimal and how much is over-burdening.  Orthodoxy says that debt greater than 90% of GDP begins to adversely affect a developed economy (the number is more like 60% for emerging economies, typically because the interest rate is higher).

Many economists will also tolerate a cyclical increase in these figures during times of economic duress or war.  Most western economies are currently running a higher cyclical debt to try to fill the gap created by the current recession.  This is on the basis that the recession will come to an end (hence it being cyclical), GDP will grow strongly again, and debt as a proportion of GDP falls back to normal levels.  In layman’s terms, we get richer again and the money we have borrowed becomes more proportional to our wealth.  Since GDP for most countries continues to grow over the long run, the borrowing of countries (in absolute terms) will usually continue to grow year on year as well.

Given the short-term nature of much of politics, unfettered access to unlimited borrowing is not necessarily a good idea.  In the US government has a debt ceiling for that reason.  That means it is restricted by Congress to borrowing a certain amount of money (just over $14trillion currently). In the last 10 years, with both parties in charge of executive and legislative branches of government, the debt ceiling has been raised 10 times with little or no fuss.

Then-Senator Obama did vote against a debt ceiling increase in 2006.  At that time he said:

“The fact that we are here today to debate raising America’s debt limit is a sign of leadership failure. It is a sign that the U.S. Government can’t pay its own bills. It is a sign that we now depend on ongoing financial assistance from foreign countries to finance our Government’s reckless fiscal policies. … Increasing America’s debt weakens us domestically and internationally. Leadership means that ‘the buck stops here. Instead, Washington is shifting the burden of bad choices today onto the backs of our children and grandchildren. America has a debt problem and a failure of leadership. Americans deserve better.”

At that time, Obama’s real beef was around choices made by the Bush administration – mainly the famous Bush tax cuts (around $350bn per year) and the war in Iraq.

What is different today now that he is President Obama and is the person in charge of the country – now that he is the “leader”?

Actually – nothing is different, except for the President’s approach to the current military engagements in Afghanistan and Iraq, which he will argue is all about making the best of a bad job handed to him.  That we are now bouncing around in the aftermath of recession is no excuse for lack of leadership.

It comes back to the same ideological battle between left and right.  The USA needs to reduce its deficit.  The question is how.  Should it be entirely through cuts in spending, or should the country raise more revenue by increasing the amount of taxes collected.

On the right, people believe that the interests of business and business people should remain unfettered.  That in this delicate economy it is not a good idea to disincentivize “job creators” from investing their money into value-adding, job creating activity.   The Republican party is also in the grip of Tea Party activists – this has helped to back their politicans into an absolutist corner.  They have two main soundbites – that the president is “obsessed with tax increases” and that “tax increases are job-killing”.

On the left, many Democrats are equally absolutist about not cutting any of the main entitlements and safety-net programs, such as healthcare and social security.  They will point out that the richest people and companies in America need to pay more of their fair share.  They also like to say that “cutting spending will put America back in recession.”

These narratives are not new by any means.  But the levels to which they are unchallenged in political coverage is disturbing.

For example, both George Bush Snr and Bill Clinton raised taxes and yet they helped initiate a period of significant growth.

And there is no evidence whatsoever that smart cuts in benefit entitlements (for example through means testing) would have any significant impact on the economy.  Democrats who insist that benefits and entitlements cannot be touched at all have themselves lost touch with reality.

Without rigourous, evidence-based, debate on the narratives, the media habitually turns to the court of public opinion.  On this, the polls are split depending on the question that you ask.  The majority of Americans when asked “do you want to pay more taxes?” will say no. (Republicans don’t talk about polls that ask if the richest people and companies should pay more taxes).

However, it seems that the majority of Americans DO believe in a balanced approach, and the ratio of cuts to tax increases seems to be about 3 to 1.  $3 trillion of cuts and $1 trillion of new revenue is envisaged in President Obama’s grand plan and he is, to his credit, trying to appear statesmanlike and fatherly to the process.

Obama’s plan, in theory, seems to be the best approach.  One can (and Republicans do) carp about whether the cuts will be smoke and mirrors, or if they will really happen.  But with two weeks until the August 2nd deadline the country, the markets and the government need to see a clear strategic goal that the country can work to.

It looks to this foreigner as if the Tea Party Caucus is holding the country to ransom.  I think that most politicians on both sides would normally have expected to reach a deal of some sort, but the fear of Tea Party activists is preventing moderate Republicans from exercising their political skills (by any definition one could see a 3 to 1 ratio of spending cuts to tax increases as a victory of sorts for the “less government” camp).

The American electoral system is partly to blame.  Primaries, two-party dominance, a biannual election for all lower house seats are all part of creating this environment where the few (rather than the simple majority) can exercise democratic tyranny over the nation.  Don’t expect that to change.  But do hope that wise and calm heads can prevail in the next two weeks.

PS Just after publication of this posting the Senatorial Gang of Six (3 Dem, 3 GOP) published an agreed way forward that follows the 3:1 ratio of cuts:taxes.  Some are gravitating to this as a way forward.  It may garner 70% of votes in the Senate according to one Republican source.  It remains to be seen if their junior partners in the House will be able to embrace it.  The Tea Party leadership today declared that ANY Representative who votes to raise taxes will become a target for them next year in the elections.  I understand the principled stand of some genuine small-government Tea Party folks, but the tail cannot wag the dog.

From → General, Politics, USA

One Comment Leave one →
  1. Patrice permalink

    I agree with your basic arguments here, especially in regards to our electoral system. However, when Obama commented on the debt ceiling and voted against it, it was a symbolic vote to get the Senate to pay attention to the ballooning deficit. There was not a party movement to vote against raising the debt ceiling and Obama knew his negative vote would have no effect on the outcome. If Congress had listened to Obama then and started doing their job instead of continuing to ignore growing entitlements and spending even more money, we would not be voting on the debt ceiling now. Good to find you again, and find you still commenting on how things are done (or not as the case may be!).

Leave a Reply