Deal that made everybody equally unhappy!
Summary
The deal on the debt ceiling reached in Washington this week has two parts:
Part 1:
In summary deal reached in the Washington allowed for a debt ceiling to be raised by $1T while at the same committed to $917B in spending reductions over 10 years. These 917B are roughly come from $350B cuts in military (read Republican compromise) and 391B come from other discretionary programs (read Democratic compromise) and rest comes from interest savings.
Part 2:
Additionally deal requires that additional $1.3T in savings have to be agreed upon and passed as a law by the end of November. If agreement is not reached by the end of November than automatic reduction will be enacted that will be painful for both parties. Automatic reduction includes $500B reduction in military spending (read painful to GOP) and $500B reduction in entitlement programs, like Medicare (read painful to Democrats) and $200B interest savings.
Needless to say automatic triggering of savings which spreads equal power to both parties is my favorite part as it will create strong incentive for both parties to come up with a sensible compromise without putting national credibility at stake again.
In summary the deal will reduce the deficit by roughly $2.3T over next ten years.
Basic Implications for GOP, Democrats and Tea Party:
GOP: The apparent winner in the debate got the upper hand by forcing the no tax hike. But also put at stake military spending and hence the funding of current wars.
Democrats: While looking like getting a slightly losing hand, they were able to push the discussions of any further debt ceiling to past 2012 elections and came out looking like a party that would like to compromise to move things forward.
Tea Party: Biggest winner in terms of political clout. Not only Tea Party asserted its tremendous influence in the Congress but also woke up even parts of GOP about the potential threat it can pose to GOP itself.
Broader Implications
Putting aside the details of the deal, which are mildly interesting, lets discuss what does this mean for US and the world. First and foremost this whole discussion on debt ceiling was a internally focused political facade. This was not a debt problem similar to the problem that Greece or maybe even Italy is facing. US debt is still highly in demand and US still owes significant portion of its debt to itself. In other words there was not a real market situation where US can not sell its treasury bonds or investors were demanding heavy interest increases on US bonds. Highly sought after US debt is still in demand and debt ceiling is an internal self control mechanism to ensure that US does not put itself into excessive debt.To put it in perspective we have raised the debt ceiling 102 times in the past... or roughly once every year. So in the scheme of things this is a common everyday business. Especially when you have inflation of 2-3%, it makes sense that your debt will go up at least at a similar rate or the nation will be under leveraged. So as opposed to some underlying economical problem, the focus of this debate was political to position both parties as big bold decision makers for the 2012 election.
Having made the strong point above, let me state that US debt has mushroomed at an alarming rate in last 15 years and it does need to be controlled. Therefore this debate was timely and healthy topic that needed to take place. However problem started with how this debate progressed and how it undermined the confidence of the whole world in the US political system and its ability to manage itself in a reliable and mature manner.
Last month the whole world watched US government trying to resolve its own self imposed or self created crises. And what the world saw was a painful soap opera of bickering politicians and antics reminiscent of Real Housewives of New Jersey ... full of drama, bickering, and creation of armageddon sounding dramatic antics. Even if you believe it was a necessary fight, we should be embarrassed that the world saw us making the sausage in the most filthy way.
As Americans we were embarrassed but I feel Chinese, Europeans and Africans were dumbfounded. They were asking if American political system is this unreliable? Should they really be concerned about the US debt they are buying? Moreover will America really go into default? These were the questions that were not even in the lexicon of the world before. The dependency of US debt was so solid that all the financial models in the world are built around it. We took one thing that the world never ever questioned -- ability of US government to pay its obligations -- and put it under doubt. In order to make it more dramatic and sensational, media and the politicians played it to the max, while not realizing that we are putting the trust of the world in US at risk.
They say that one of the main jobs of a leader is to bring certainty and confidence amidst uncertainty and fear. This is the role America has played during past global financial uncertainties. And in this time of global financial uncertainty, when many of the Asian and African nations, including China and India, who heavily depend on the massive American consumption for their growth of the economy were also shaken with the potential American default. Due the position of the American economy in the world, any default by the US will cause global recession and potential depression and while we avoided such calamity, the theater that was created to reach a deal caused this nation some credibility as a leader and we will need to work hard to win it back.
In the end each party may have achieved some political goals, but as a nation we lost our credibility that we have built over last two centuries. Credit ratings agencies may not downgrade US debt, but the world may be a little more cautious in buying our debt fearing similar future stand offs in our increasingly divisive political landscape. And therefore result could be the same as if our credit rating was downgraded!
At the time when Chinese system of market and government interplay is showing an alternative to American model with fast and continued growth, dysfunction showed by our government over last several weeks and dramatization of it by our media only weakens America.
In summary I am less concerned about American economy and even our current debt -- I am a strong believer that American economy will come out of its doldrums and will march along with rigor. However I am concerned about the political implications of how we are making the new policies and its impact on our perception by the world.
On a positive note:
Regardless of the negative impact, now that we are past the discussion, it is important to use this deal to kick start strong fiscal reforms that can bring this nation back to its roots of a growth focused economy. This deal has put some drastic cuts in our spending and while it puts our economy at risk by not allowing any potential stimulus if needed, I hope our politicians will use the next round of discussions to put the fiscal plans in place that will help focus the government on where it can help the country most while making America an attractive place for entrepreneurs and corporations to do business.
Lastly I want to address the naysayers who think that this marks the beginning of decline of American dominance in world economy. I think nothing can be farther from the truth. Probably these naysayers don’t remember the same sentiment during 80s about the rise of Japan or the impact of Great Depression. This nation rose from both events stronger and more powerful. I will write more about why I am still strongly bullish about US economy and US as the superpower in my next blog entry.
Labels: Debt Ceiling, Economy, US Government, World Economics
