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The Missing Sound Economic and Political Fundamentals of the Debt Ceiling Deal
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By David A. Hollingsworth

The week of July 31st, 2011 was a historical one in a number of important respects. On August 1st, the United States House of Representatives voted 269 to 161 to pass the debt ceiling deal: the deal that will keep the country out of default and reduce the deficits by at least $2.1 trillion over the next decade. On August 2nd, the United States Senate voted 74 to 26 for its passage, which was signed immediately by President Barrack Hussein Obama. But there’s more to the deal than that. Under the deal: - The framework will raise the debt ceiling immediately by $400 billion, then by an additional $500 billion after September. - The framework will immediately cap domestic and defense spending, which will result in cuts of $917 billion over ten years. - The framework then calls for additional deficit reduction (between $1.2 trillion and $1.5 trillion worth) to be determined by year’s end and imposed over the next ten years. - The Bipartisan Debt-Reduction Committee will, until Thanksgiving, propose the second round of deficit reduction. Those proposals would be guaranteed by an up-or-down vote without amendment by December 23rd. If the Committee will propose the $1.2 to $1.5 trillion in cuts and Congress approves, then the debt ceiling will be increased dollar for dollar. However, if the Committee deadlocks or comes up with less than $1.2 trillion in cuts, or if Congress votes down the Committee’s proposals, then the debt ceiling will be raised by $1.2 trillion. - Programs that help low-income Americans will be exempted from this round of cuts, including Social Security, Medicaid, benefits and pensions for veterans, food stamps, and Supplemental Security Income. With Medicare, the framework would restrict cuts to it no more that 2 percent of its costs. And those cuts would not affect Medicare benefits nor would they increase seniors’ costs. - Lastly, the across-the-board cuts would be avoided if both the House of Representatives and the Senate pass the Balanced Budget Amendment to the Constitution and send it to the states for ratification before the year will end (Sahadi, 08/02/2011: pp. 1-2). After over three months of fierce debates over controlling our spending and put our house back in order (fiscally speaking), one could have thought that the deal is the crucial first step in fixing the nation’s debt crisis. To be explained below however, not really. Robert Reich, former United States Secretary of Labor and now Chancellor’s Professor of Public Policy at the University of California at Berkeley, argues in his blog “Ransom Paid” (dated August 1st) that the deal will not raise taxes on America’s wealthy and most fortunate. Moreover, it will hobble the government’s capacity to respond to the jobs and growth crises. To Reich, those crises are the real impediments to our country’s prosperity, not the budget deficit. And to many people here and abroad, the deal, though preferable to the unfolding economic catastrophe of a default on US’ debt, will do little to deal with the ailing economic fundamentals and the every-day bottom line for most Americans. In fact, in the New York Times and CBS News Poll taken on August 3-4, Sixty-two percent of those polled believed that creating jobs should be the higher priority now, not cutting spending. Also, 63 percent believed that raising taxes over households earning $250,000 a year or more should be implemented to lower the budget deficit, versus 34 percent who did not believe in increasing taxes upon the same income group (The New York Times, 08/04/2011: pp. 1-2). But the political process in getting the deal passed proved in the end to be extraordinarily damaging. As expressed by those who were watching how this process unfolded, America to them looked handicapped and inept to put its house in order. Let’s keep in mind how fierce the battle for a budget compromise became, with the President who warned that without the deal, Social Security and Medicare would likely be slashed. It was again the back and forth political process that Americans hoped would be the thing of the past once they elected Illinois Democratic Senator Barrack Obama to the presidency in 2008. Alas, it is not, and in the same New York Times and CBS News Poll, 85 percent believed that Democrats and Republicans should have compromised some of their positions in order to get things done, versus 12 percent who believed that they should have stuck to their positions. Because of the perceived ineptitude, 66 percent of Americans polled expressed pessimism in the ability of Congress to deal with issues affecting this country and 82 percent disapproved of the way Congress was handling its job. And as far as how negotiations on the debt ceiling have been handled were concerned, 47 percent disapproved of how President Obama handled those negotiations, while the disapproval rates for both Republicans and Democrats were 72 percent and 66 percent respectively. However, what is perhaps to most damaging response of all, is the one that answered the question on whether they thought the recent disagreements about raising the debt ceiling were mostly about doing what was best for the country or mostly about gaining political advantage (with the 2012 elections looming). Eighty-two percent believed that the recent disagreements were mostly about gaining political advantage, versus 14 percent who viewed them mostly as manifestations of what was best for the country (The New York Times, 08/04/2011: pp. 1-2). The apparent lack of confidence over the deal itself and in the political process in getting it passed was manifested by the global markets, which altogether lost around ten percent of their value during that fateful week. Thursday, August 4th was the watershed in losses; The Dow Jones Industrial Average lost over 500 points, the most since late 2008 when the handling of the economic and financial crises were then seen as unattainable. Global markets in Europe, Asia, and Latin America saw 3-4 percentage drops of their values by the close of that business day. And to cap off the highly tumultuous week, Standard and Poor’s (S&P), on Friday night, downgraded the creditworthiness of U.S. sovereign debt from AAA to AA+ with a negative outlook, citing, among other things, lack of leadership sufficient enough to deal with its fiscal problems in the medium term. It means that it lost confidence in US’ handling of its debts denominated in dollars, and in the political progress that is looking more and more amorphous by the day. S&P’s move, itself unprecedented, now means that borrowing will be more expensive (not just for the US government at all levels, but also for private citizens and companies who would like to borrow to buy a home, a car, or to open or expand a business). And with the unemployment rate still hovering over nine percent, S&P’s move further hampers the prospects of hiring in an environment where hoarding cash, cutting workers while increasing workloads upon current ones, and transferring work overseas, are now the new norms. The United States avoided a default, at least for now. But with the significance of S&P’s decision that is very high indeed, perhaps a default should have occurred to make more meaningful yet painful policies that would build this country back to its preeminence it enjoyed after World War II. The late Hugh Carey, a Democrat who served as New York’s governor from 1975 to 1982, and who passed away on August 7, 2011, understood that well as he helped save the state from near collapse during his term in office. Needless to say, we have rougher days ahead. Washington is angry at the decision, while others, like Euro Pacific Capital’s CEO and Chief Global Strategist Peter Schiff criticized it for not going far enough (and sooner). Besides, China’s credit rating is less than that of the United States (at AA-, but with a more robust economic growth and a more stable sovereign outlook on its debt). Others, on the other hand, have opposite opinions. Robert Reich, in his August 7th blog “Why S&P Has No Business Downgrading the U.S.”, sees S&P’s move as an intrusion into American politics. Such a move is, as he calls it, ironic, because of its failure (and the failures of other credit agencies such as Moody’s and Fitch) in warning investors of the amount of risks Wall Street was taking on. And that is true, because these agencies rated these risky projects with triple-A’s. And it is also true that these agencies should have seen the eventual bursts of the housing and debt bubbles that could have averted much of the systemic collapses that occurred since late 2007. However, in the final analysis, Standard and Poor’s and other rating agencies do have a point. Let us consider the following economic realities here and abroad: - GDP growth in the United States was 0.4 percent in the first quarter (revised from a 1.9 percent growth reported earlier), and 1.3 percent in the second. Therefore, for the first half of 2011, GDP growth averaged just 0.85 percent, which is tantamount to a recession. Trade deficit on goods and services was $50.2 billion in May. - According to tradingeconomics.com, unemployment remains above 8 percent since March, 2009 and is liable to get worse. For example, HSBC announced on August 1st that it will cut 30,000 jobs by 2013 and sell almost half of its retail bank branches in the United States (Selva, 08/01/2011: pp. 1-2). More layoffs at state and local levels are coming. Also, the United States Postal Service (USPS) announced that it is targeting 3,653 post offices for closures to deal with $25.6 billion in losses since 2007 (Milner, 08/04-10/2011: p. A3). - Relating to the above fact, corporations are now hoarding roughly $2.5 trillion in cash as they continue to find ways to cut costs. - According to the U.S. Government Accountability Office (GAO), total federal debt (aka gross debt) is roughly $13.6 trillion by the end of fiscal year 2010 (GAO, 2011: pp. 1-3). The debt is now over 100 percent of GDP, which is akin to the debt-to-GDP ratios of Italy at 120.3% and Greece at 124.8% (Pope, 07/17/2011: pp. 1-3). - As Americans are earning less, but with enormous debt obligations (credit cards, student loans, car loans, mortgages), they will have less disposable income to pay taxes and put their money into savings. Less than fifty percent of Americans paid income tax in the past year. - The U.S. dollar continues to be devalued further while struggling against other currencies such as the euro, the Swiss franc, and the Japanese yen. It is increasing being looked upon as less of a safe haven for investors. Basket of currencies and investments in gold and commodities continue to be attractive options for many in the financial markets. -The state of the financial industry remains worrisome. Sixty-three U.S. banks closed so far in 2011 and 8 out of 90 European banks failed the 2011 stress test (according to the European Banking Authority or EBA). Those banks that failed were in Spain (with 5), Greece (2), and Austria (1). However, as Stephen Pope points out, 16 more banks are considered as in the danger zone (Pope, 07/17/2011: pp. 1-3). - The housing market has yet to hit bottom and it is projected that about 1.5 million homes will face foreclosures by the end of this year. Moreover, commercial real estate is far from stable. Small and medium businesses (SMBs) continue to face closures especially in the southern and mid-west portions of the United States. - Treasuries are negotiable debt obligations of the U.S. government, which are backed by its full faith and credit. The government issues those treasuries to pay for its projects. With S&P’s move in downgrading U.S. creditworthiness of its sovereign debt, however, interest rates are likely to increase, making it more expensive to borrow. Over the weekend in the aftermath of S&P’s move, foreign buyers of Europe and Asia expressed their desire to stick with treasuries (Christopher Anstey and Shamim Adam, 7 August 2011: pp. 1-5). However, as more money are being placed in those treasuries, the yield on the treasury bills (short-term treasuries) will be forced downward. Thus, investors will look elsewhere to safeguard their money. And as more credit downgrades are possible, not only from S&P, but also from Moody’s and Fitch, treasuries are likely to take an enormous hit. - Economic conditions in parts of Europe continue to be precarious. It is still possible that Italy will default on its debt obligations while countries such as Spain, Greece, Portugal, and Ireland are grappling with severe economic and fiscal imbalances. Unemployment in Spain remains at about 20 percent. - China’s economic growth is slowing and its demands for commodities are declining. That trend is likely to continue in the coming months. - To pay for ballooning debt obligations, and with the values of fiat currencies lessening in part because of money printing, the rate of inflation is still going up. And with rises in food prices and the current food crisis that’s affecting much of the globe, future social and political instabilities may become more numerous and widespread. In closing, after so much time, energy, and resources used to get the debt ceiling deal passed amidst the precarious conditions of our economies (on personal, local, national, and international levels), why is there such a pervasive feeling that so much effort was misdirected, and that our leaders essentially missed the underlying point? Is it really safe to say that the deal will even begin to address the fundamental ills of the economy, now globally interconnected with other economies and markets? In addition, is it really safe to say that the fierce debates for the deal will help our country’s reputation for years to come? The consensus to these questions veers towards the negative, with the everyday realism of the failing economy and its fundamentals that are becoming more apparent to an increasing number of people - and with a growing realization that the answers needed to combat this ongoing crisis are becoming more elusive to leaders placed in charge to come up with the solutions. With those things in mind (presumably at least and hopefully so), what say our politicians of these United States? Selected Bibliography: Anstey, Christopher and Shamim Adam. “Big Foreign Buyers to Stick With Treasuries.” New York, Bloomberg News, 7 August 2011: pp. 1-5. http://www.bloomberg.com/news/2011-08-07/biggest-foreign-buyers-to-stick- with-treasuries-after-downgrade.html Milner, Conan. “Post Office Plans Closures to Curb Massive Debt.” Washington, DC, The Epoch Times, 4-10 August 2011: p. A3. Pope, Stephen. European Bank Stress Test; Only Eight? Europe is in Peril!” New York, Forbes, 17 July 2011: pp. 1-3. http://blogs.forbes.com/stephenpope/2011/07/17/european-bank-stress-test- only-eight-europe-is-in-peril/ Sahadi, Jeanne. “Debt Ceiling: What the deal will do.” Atlanta, GA, CNN Money, 2 August 2011: 1-2. http://money.cnn.com/2011/08/01/news/economy/debt_ceiling_breakdown_of_deal/ Selva, Meera. “HSBC layoffs: 30,000 jobs to be cut in global overhaul.“Boston, MA, The Christian Science Monitor, 1 August 2011: 1-2. http://www.csmonitor.com/Business/Latest-News-Wires/2011/0801/HSBC-layoffs-30-000-jobs-to-be-cut-in-global-overhaul The New York Times and CBS News Poll. “How Americans Feel About Congress After the Debt Deal.” New York, The New York Times, 4 August 2011: 1-2. http://www.nytimes.com/interactive/2011/08/04/us/politics/how-americans- feel-about-congress-after-the-debt-ceiling-deal.html?ref=politics United States Government Accountability Office. “Federal Debt Basics.” Washington, DC, The U.S. Government Accountability Office, 2011: 1-3. http://www.gao.gov/special.pubs/longterm/debt/debtbasics.html

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