The US deficit crisis, damage already done?

The street theatre game that is the US debt default crisis rolls on with no sign of a successful conclusion in sight. Both parties blame each other for the current crisis and in some respects both are right, thought historically it’s arguably the Republicans who are more to blame than Democrats (as I discussed in my last post on this topic). The Republicans reckon the whole deficit crisis is a consequence of Democratic “bleeding heart” welfare programs, midnight basket ball and “high” taxes, while the democrats blame republican war mongering, tax cuts for the “good-olde boys network”, the financial crisis caused by Bush being asleep at the wheel, as well as Republican commitment to various special interests (i.e. giving fat government contracts to their country club golfing buddies).

I suspect Americans will find that the real cause of the deficit crisis is a little closer to home. My advice to any American is go to the bathroom and look in the mirror and you’ll find the true cause of the deficit staring back at you. The cause of this deficit crisis is ultimately US citizens themselves and their unreasonable expectations. As Andrew Sullivan puts it “...the biggest problem in this country is…they’re (the people) are big babies. I mean, people keep saying they don’t want any tax increases, but they don’t want to have their Medicare cut, they don’t want to have their Medicaid [cut] or they don’t want to have their Social Security touched an inch…You have to make a choice…”
And as Fareed Zakaria puts it “..in one sense, Washington is delivering to the American people exactly what they seem to want. In poll after poll, we find that the public is generally opposed to any new taxes, but we also discover that the public will immediately punish anyone who proposes spending cuts in any middle class program which are the ones where the money is in the federal budget. Now, there is only one way to square this circle short of magic, and that is to borrow money..”

There are in essence only three ways a government can sort out its finances, borrowing, raising taxes and cutting spending. Up until now US politicians with elections to win have had little choice but to resort to the former as the latter two would be political suicide. The US people can’t complain, they after all voted for these guys.

Another part of the problem is that many Americans still seem to think that they’re living up on the high frontier (in the back of a wagon heading west) in a “low tax” and “small goverment” economy. They’re not, the US government is a vastly bloated system, little different from the Keynesian economies of Europe that they regularly sneer at, as this Time article “United states of France” makes clear. Of course the one notable difference is that the French recognise that a big government requires high taxes to run it. Now while I’m not expressing admiration for the French, indeed I had a pop at them a few months back, but at least they know what kind of economy they’re running. By contrast the mantra from Americans is for “big government to get off our backs…except the bit that’s paying my farm subsidies and/or military contractor job and builds federal highways for me to drive on free of charge” or “put up taxes…for everyone else but me”.

Of course a third option to deal with the current deficit crisis, that favoured by the Libertarians and Tea party amounts to cutting down “big government” and that this will somehow “stimulate” the economy and magically solve everything. Libertarianism is essentially to economists what the Atkins diet is to fat lazy people – an excuse to do nothing, but delude yourself in to believing things are changing. There is already a country where “big government” got off people’s back. It’s called Somalia. If libertarians were right Somalia should now be the richest most dynamic trading nation on earth, in fact it’s actually one of the poorest and most dangerous places on the entire planet. The country is wholly dependant on food aid, in and out of famine and virtually all economic activity revolves around the illegal kind (piracy, kidnappings and banditry) or the economic “stimulius” that is the presence of African Union peacekeepers. Of course as I pointed out in my past post the irony here is that the very people proposing such policies in American are the very people who are most dependant on “big government” spending!

The truth is that if the US government is truly serious about dealing with its current deficit crisis then they need to either raise taxes across the board or drastically cut spending, which as I highlighted before will mean substantial cuts to the military budget (as the conservatives were forced to impose on the UK) as well as various “special interest” line items such as farm subsidies, federal infrastructure building programs and the various Bush era “corporate welfare” programs. Any tax rises, even if performed with the aid of spending cut will have to be fairly sharp (e.g. introducing VAT, road taxes or the high petrol duty we pay in Europe and/or repeal most of the Bush era tax cuts). For America to sustain itself with European levels of public spending will naturally require European levels of taxation. Anything else, as congress now propose (both parties), are merely cosmetic cuts that will probably do more harm than good.

Indeed a fatal flaw in the proposed cuts both Republican and democrat have put forward is that they are dependant on a sudden sharp increase in tax revenues at some point in the future (see graph here with more on the issue found here). I would question whether this is a reasonable assumption, indeed all the evidence is that the US/global economy is still slowing down and may even lurch back into recession, something which a sudden cut in federal spending could easily provoke.

Now its possible that some sort of a deal might still be pulled out of the bag before Tuesday, but it will be little more than a fudge, a political face saving exercise. As Steph Flanders at the Beeb points out, the US may simply re-write the rules on what actually consitutes a default, much to that annoyance of the Europeans, who are getting hammered by the rating agencies even though none of them are arguably as close to the edge as the US. And that is the wider problem for the US. The debate over this issue has laid bare to the watching world that the political will of Americans to overcome their deficit simply isn’t there and anyone holding US bonds has reason to be wary as it’s likely that AAA rating ain’t worth the paper it’s printed on.

Already there are mutterings coming out of China (America’s biggest lender) along those lines. While I doubt they would stop lending to the US tomorrow (that would put at risk the money already lent) I won’t be surprised if international lenders will now show a reluctance to lend to the US as freely as they did before, diversifying they’re portfolios, slowly cashing in and selling off existing bonds, etc. Of course this will mean the US government will find it increasingly difficult to raise money, at least without pushing up its interest rates – which would of course instantly wipe out the deficit reduction plans proposed, and put the US into the same deficit “austernity” spiral that several European countries are now caught up in.

So even if the US can avoid national bankruptcy on Tuesday (and again, I’d be very surprised if they actually did default on Tuesday) the fraca in Washington these last few weeks has merely demonstrated that a future US default in its debts is a near mathematical certainty. The only thing that can prevent this is a major change in US government policy and that would require a significant swing in US public opinion. i.e. a willingness by Americans to accept that everyone has to pay more taxes (although the rich will inevitably have to take the biggest hit) and that public services that they directly benefit from must be cut back. Until that happens, lenders to the US need to realise it’s simply a matter of “When?” and not “IF?” the US will go bankrupt.

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4 thoughts on “The US deficit crisis, damage already done?

  1. Pingback: US election update | daryanblog

  2. Pingback: What about the deficit? | daryanblog

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