April 28, 2011
by Irwin Stelzer
So the sovereign debt of the American government has been downgraded. Not last week by Standard & Poor's, which merely put it on negative watch.
But last November, by Dagong, China's rating agency, which downrated it from AA (its highest rating) to A+.
Of course, Dagong had reasons of its own: the Chinese regime, with $US1.2 trillion ($1.12 trillion) of US government IOUs, wants to show it might stop buying Treasuries if America threatens to pay its debts in depreciated US dollars. So far, so fair.
But Dagong also used the occasion to take a few swipes at "the serious defects in the US economic and development management model" -- those inherent contradictions of capitalism that so disturbed Karl Marx -- and to argue that America's problems cannot be solved by an increase in the value of China's artificially undervalued currency.
Not that S&P was acting out of some sudden flashing of a danger signal by its economic model, if it has one. The rating agencies have been widely criticised for lavishing AAA ratings on securities backed by subprime mortgages, and missing the fact that Greece's fiscal condition is more than a little different from Germany's.
So here was a chance to issue a warning: if it proved prescient, if the president and congress could not bring the deficit under control, the S&P raters could indulge in "we warned you". And if the politicians do finally move to rein in President Barack Obama's deficits, they can say: "It was S&P wot won it; we frightened them into action." It's win-win for the rating agency.
There is, of course, no possibility that America will default. But there is a real possibility that it will repay its creditors in trillions of newly printed dollars of shrunken value. After all, in the face of a deficit running at or close to double digits, Obama submitted a budget for next year that increased spending and the deficit.
That so hurt his popularity that he has become a born-again deficit cutter. A new poll shows that 44 per cent of all voters intend to vote against the president next year, 37 per cent say they will vote for him, and 18 per cent are undecided. Against Mitt Romney, regarded as the most plausible Republican candidate even though "the Donald" trumps him in polls of Republican voters, Obama's 15-point lead in January has shrivelled to a single percentage point.
The President is now on a national tour to raise the $US1 billion he says he needs to finance his re-election campaign. And he is promising to bring the deficit under control largely by taxing the rich, those "millionaires and billionaires".
Unfortunately, there aren't enough of those to make a dent in the deficit even if they were hit with a 100 per cent tax rate. Meanwhile, the Republicans say they will close the budget gap by converting Medicare, the government healthcare plan, into a subsidised insurance-cum-voucher system for future entrants, a sensible plan unlikely to survive attacks by demagogues.
The government will soon hit the legal limit of its borrowing power, and it will take a congressional vote to allow it to borrow more -- or default. Obama, who when in the Senate voted against lifting the debt ceiling because that would demonstrate an absence of "leadership", now wants the ceiling raised, no strings attached. The Republicans are busily attaching strings to their vote to raise the ceiling, and Treasury secretary Timothy Geithner and Vice-President Joe Biden are attempting to fashion a compromise. They will succeed: neither party wants to be tagged with the label of defaulter-in-chief.
All of this has unnerved those markets that rely on a stable US dollar. The prospect of dollar depreciation, along with higher demand, is driving commodity prices through the roof. It is also leading to new interest in the use of other currencies to settle international transactions, with China pushing its yuan as the alternative currency of choice. Last year only 0.5 per cent of China's trade was settled in the Chinese currency; in the first quarter of this year, it was 7 per cent.
Meanwhile, the American economic recovery continues, haltingly and at a slower pace, about 2.5-3 per cent, than is necessary to bring unemployment down rapidly, but continues nevertheless.
There are signs that a new wave of innovation may be about to persuade the nation's chief executives to begin investing some of the $US2 trillion sitting in their vaults. Earnings reports from Apple, IBM and Intel all suggest that consumers continue to lust after the new, innovative gadgets that hit the market every week.
Equally robust reports from GE, United Technologies and Honeywell suggest that the hi-tech end of the manufacturing sector is in full recovery mode and may give the economy a boost that makes it grow faster than economists are predicting.
A political settlement would give business and consumer confidence a shot in the arm, an important aid to growth.
My own guess is that we will see a two-step settlement despite the ill will generated by the President's intemperate attack on his opponents as people who want to let "children with autism or Down's syndrome . . . fend for themselves".
(Sarah Palin has a Down's syndrome child.)
First, the debt ceiling will be raised as part of a package of some spending cuts and an agreement to set broad spending limits.
Then the parties will set out competing visions of how they intend to refashion the role of government so that it can live within those limits. Democrats will push for tax increases, Republicans for spending cuts.
The winners will return to Washington in January 2013 and eventually agree to a mix of both, the weight given to cuts and taxes determined by which party captures the White House. Messy, but democracy often is.
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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