Debt deal agreed for now – but America is being a bad economic citizen of the world

16th October 2013

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Congress has struck a deal over raising the $17 trillion US debt ceiling. The US Republican Party including its Tea Party faction in the House of Representatives is set to allow the debt ceiling to be raised. They have accepted that they cannot link agreement to a delay to President Barack Obama’s healthcare reforms.

The deal is temporary, delaying the next argument only until February next year.

The US will not default for now, and most people think it is very unlikely to do so any time soon, which is one reason why markets globally did not go into meltdown.  China, as a huge holder of US debt, made its misgivings clear as the Guardian reported a few weeks ago.

This is of course a crazy way of doing politics and economics. But perhaps it does no harm to run through some reasons why it is just so crazy.

First if the US defaults it would throw the world into financial turmoil just five years or so after the great financial crisis began. Veteran investor Warren Buffett has called the debt ceiling stand-off and threat of default a political weapon of mass destruction as the Globe and Mail reports. Buffett certainly has a neat sense of timing. Ten years ago, he called complex derivatives financial weapons of mass destruction.

Yet perhaps more importantly Larry Fink, chief executive of Blackrock, suggested it could surpass the impact of the Lehman’s collapse as CBS News reported.

The argument and shutdown has already shaved 0.3 off US GDP according to Goldman Sachs as Marketwatch reports, so US politicians have collectively managed to damage their own economy. Standard & Poor’s says it has cut its forecast for US growth this year by 1% to 2%. It says the existing shut down of a lot of the Federal Government took $22bn out of the economy.

These experiences are now becoming regular. Arguments and debates about the debt limit have arrived almost periodically. This suggests that the US will continue to argue while everyone else watches aghast from the sidelines though perhaps this chapter was particularly heated because it was a last ditch attempt to stop Obamacare.

Indeed, aside from this issue, there is actually a very serious long term challenge due to the level of US debt. It will need dealt with, and though opinion divides on the timing and on just what percentage of debt restricts how much growth, the US will need to grapple with it.

However, most economists think that it is premature to do so now, though many would welcome a long term credible plan for debt reduction though one that does not involving pitching the US government, economy and globe into crisis.

One reason that the US is able to take on so much debt is that on most counts it is economic number one. The dollar is the world’s reserve currency and, ironically, because of this the US can hold more debt because more countries want to hold dollar denominated assets especially Treasuries.

But this sort of behaviour may help undermine that status. The US is not being a good economic citizen of the world even if its economy is the most powerful. Maybe it is sign that one day, it won’t be.

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