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Tuesday, August 2, 2011

The Debt Deal

Paul Krugman is right.  Obama has given in to the right wing extremists in the Republican party.  Once again America has shown its uniqueness.  In the worst possible way.

Start with the economics. We currently have a deeply depressed economy. We will almost certainly continue to have a depressed economy all through next year. And we will probably have a depressed economy through 2013 as well, if not beyond.

The worst thing you can do in these circumstances is slash government spending, since that will depress the economy even further. Pay no attention to those who invoke the confidence fairy, claiming that tough action on the budget will reassure businesses and consumers, leading them to spend more. It doesn't work that way, a fact confirmed by many studies of the historical record.

Paul Krugman's overstating the case a little here, since its seems to me that most of the cuts are later rather than earlier, and "entitlements" had to be reined in because they were growing too fast.  But there will be big cuts shorter term as well.  And that's batty.  Yes, the deficit does need to be cut, but not savagely, and not yet:

Indeed, slashing spending while the economy is depressed won't even help the budget situation much, and might well make it worse. On one side, interest rates on federal borrowing are currently very low, so spending cuts now will do little to reduce future interest costs. On the other side, making the economy weaker now will also hurt its long-run prospects, which will in turn reduce future revenue. So those demanding spending cuts now are like mediaeval doctors who treated the sick by bleeding them, and thereby made them even sicker.

And here, he is again exactly right:

And then there are the reported terms of the deal, which amount to an abject surrender on the part of the President. First, there will be big spending cuts, with no increase in revenue. Then a panel will make recommendations for further deficit reduction - and if these recommendations aren't accepted, there will be more spending cuts.

Republicans will supposedly have an incentive to make concessions the next time around, because defence spending will be among the areas cut. But the GOP has just demonstrated its willingness to risk financial collapse unless it gets everything its most extreme members want. Why expect it to be more reasonable in the next round?

In fact, Republicans will surely be emboldened by the way Obama keeps folding in the face of their threats. He surrendered in December, extending all the Bush tax cuts; he surrendered earlier this year when they threatened to shut down the government; and he has now surrendered on a grand scale to raw extortion over the debt ceiling. Maybe it's just me, but I see a pattern here.

 This is The Economist's take:

If Republicans are the clear winner from this deal, the economy is the loser. An ideal deficit-reduction package would have coupled near-term stimulus with long-term consolidation that stabilised then reduced the debt as a share of GDP. This deal certainly doesn’t do the first and it’s unclear that it will do the second. True, it does not add significant new fiscal tightening: total discretionary spending would be a mere $7 billion lower in fiscal 2012 and $3 billion in fiscal 2013 than current levels, according to a Democratic Senate fact sheet. On the other hand fiscal policy is already set to tighten automatically; the International Monetary Fund estimates by the equivalent of 1.4% of GDP. Mr Obama had hoped to extend the payroll tax cut as part of the deal. He may yet do so during the Congressional negotiations, but that seems a fading prospect. It is striking that last Friday’s appallingly weak GDP data did nothing to shape the deal any further in the direction of near-term stimulus.

As for long-term fiscal consolidation, the deal also falls short. Total deficit reduction of $2.5 trillion is less than the $4 trillion that bipartisan groups and political leaders had more or less agreed was necessary to put the debt on a meaningful downward path relative to GDP. It’s also the number Standard & Poor’s, a credit rating agency, had suggested was necessary for America to avoid a downgrade to its AAA credit rating. And it’s worth noting that now that GDP has been revised to be smaller than we’d realised,  debt is larger as a share of GDP.

In the end, hopes for a grand bargain that addressed entitlements, taxes and near-term economic support ran aground on the harsh reality that all these things would require bridging profound philosophical differences that have developed over decades. The odds that the next few months will yield a different outcome seem low: further brinkmanship (albeit of a less terrifying sort than seen in the past weeks) is more likely. That has become the routine way that fiscal policy gets made in America. True, stockmarkets rallied with relief that the most reckless path has been avoided. Meeting such a low standard should hardly be considered a vote of confidence in America’s fundamental fiscal and political maturity.

Meanwhile, while US pollies focus entirely (and ineptly) on domestic issues, China continues to grow at 9% a year and the US at 2%.   In 10 years time, the US economy will be 25% larger, the Chinese 240%.   China will be the world's largest economy. Those of us who admire the US have cause for much concern.

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