As suggested by us, the U.S. was able to cut- through a last minute Debt Deal on August 2 to avert possible default, after almost 2 months of haggling over the issue, and pressing over priorities of each other parties. Most of the proposed rise of debt ceiling ($900 billion in this year and subsequently $1.2 to 1.5 trillion) would be ploughed-back by deficit reduction of $2.4 trillion over the next 10 years.
The bill tilted heavily on the Republican agenda- not raising any new revenues by NOT incurring new taxes on American corporate, WITHOUT reducing any significant Defense budget. It only focuses on deficit reduction by cutting expenses. The common objective of achieving a balanced fiscal condition could not be met without instituting an increased revenue earning (by higher taxation mostly from rich corporates and individuals), vis a vis curtailing onerous budget spending. The cumulative deficit reduction of $2.4 trillion, proposed to be made within next 10 years, is less than the figure $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 that Standard’s and Poor, the credit rating agency, had suggested necessary for America to avoid a downgrade to its AAA credit rating. Between American battle of conflicting priorities- maintaining fiscal balance as well as maintaining political and military supremacy - the latter clearly prevailed. The current reduction of defense budget proposal, in inflation adjusted dollars, kept Defense spending higher than it was at the height of the Cold War. Adjusted for inflation, the U.S. spent at most $580 billion a year on defense at the height of the Cold War. In the 2011 fiscal year, the Pentagon’s baseline budget is $549 billion, with another $159 billion allotted for the wars in Iraq and Afghanistan, for a total of $708 billion. That total figure drops slightly to $670 billion in the 2012 budget proposal.
The cloudy process of deficit reduction has lots of catches within it. The budget employs a BASELINE that automatically adds an upward adjustment for the rate of Inflation. And then, on top of this, the budget is automatically adjusted upward by another 7.5% each year! So, every year, the budget increases by 7.5% plus an adjustment for inflation!
So, the bottom-line is, the U.S. budget would be increasing by $10 trillion over the next 10 years. Now, if the planned deficit reduction materializes, the budget will only increase by $7.5 trillion! So, it’s no surprise that S & P on August 5 had downgraded America’s sovereign rating for the first time since the U.S. won the top ranking in 1917. This entails even higher costs on top of debt-behemoth that is on the economy’s shoulder, translating in higher interest rates. Projections are that the higher interest rates triggered by a downgrade could knock 0.4 percentage points off U.S. growth. That’s a big deal when the economy is growing at just 1.3 per cent (as per second quarter GDP data, annualized). And it’s worth noting that now that GDP is revised to be growing insignificant, debt is larger as a share of GDP (with gross debt ratio to be 96% of GDP, as of June 2011). This massive debt repayment program would have to be met by further monetary expansion.
Where will this extra money come from? Clearly, the Fed will continue its “money-pumping” program, by buying out massive amounts of Treasury Securities which are beyond purchase demand by investors. It will continue to erode perilously the value of money i.e. U.S. Dollar further and further.
So, 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 at first stabilized and then reduced the debt as a share of GDP. As it transpires, this deal certainly doesn’t do the first and it’s unclear that it will do the second. So, in the final count- as political eventualities have shown- the fiscal chaos in the U.S. goes on. It’s like a spiral the continues unbroken. And, as mentioned, it does have monetary implications, which erode further the U.S. Dollar value.
