Breathing space for America, but for how long?

EDITORIAL
Breathing space for America, but for how long?
By The Nation
Published on August 3, 2011

Debt ceiling deal is a short-term fix for long-term problems that endanger economic recovery for rest of the world

Although the US House of Representatives on Monday night managed to pass an emergency compromise to allow the government to up its borrowing, the US economic crisis is still far from over.

As of press time, the legislation to increase the debt ceiling is being hurried through the Senate. But once rubber-stamped, the agreement will only help the US administration pay its bills. After weeks of confrontation and suspense, the House of Representatives' vote on Monday simply eased worries that the US would default on its debts for the first time in history. But the legislation still falls far short of addressing the fundamental issue facing the US.

While the emergency compromise, passed by a vote of 269 to 161, enables the US to stave off immediate economic catastrophe, lawmakers on Capitol Hill have yet to address the structural reform that will enable the US economy to recover. The deal may allow the US administration to borrow more to avoid defaulting, but America is still struggling with stalled growth and a high unemployment rate of 9.2 per cent.

The US economic woes are a result of years of big spending. The financial meltdown triggered by the sub-prime crisis in 2008 dragged on because of the failure to reform. The administration's stimulus packages have not produced the positive economic "multiplier effects" the White House had hoped for. All these issues have snowballed into a heavy weight of economic woe, evidenced by the soaring deficit.

Though an agreement was finally reached in the Lower House, the deal has not spelt out how the US administration will turn around the economy. Washington is in desperate need of a long-term plan and structural reform to promote stronger growth and increased revenue, if it is to escape this economic trough.

The dilemma facing the US administration is whether the cash-strapped nation should spend more to stimulate growth or, alternatively, apply austerity measures to slash public spending. The Congressional Budget Office expects the present deal to cut federal spending by US$2.1 trillion over 10 years. But some economists have pointed out that austerity might not be the solution to reversing the economic slump.

Passing measures to fix the US economy is being made more difficult by a polarised Congress in which lawmakers have taken up entrenched positions on different sides of the aisle. The ultra-conservative Tea Party camp will shout down any attempt to raise taxes while liberal Democrats are adamant that social benefit programmes be maintained.

But while the debt ceiling issue will be decided in domestic political circles, the crisis Stateside is having serious repercussions for the global economy. The US debt-service ratio will hit the credibility of dollar-assets. Many countries in Asia hold billions of dollars in US treasury bills as part of their foreign reserves, with China and Japan holding the largest portions of US debt.

The US debt problem also puts pressure on Asian currencies, especially the yuan, because the crisis will potentially further weaken the value of the dollar against currencies in the region. In fact, the debt-ceiling impasse in recent weeks pushed up prices on Asian stock markets.

America's indebtedness could bring upward inflationary pressure, too, as the US is also likely to inject more money in a bid to boost the economy. But at the same time, the prospective cuts in federal spending could affect domestic demand. If that is the case, Thai exporters to the US market can expect to suffer.

The US crisis is also a glaring lesson in how the global economy has become closely interconnected. It is no surprise, then, that the rest of the globe is watching anxiously to see whether the world's biggest economy can find a solution to get out of this mess.

This week's deal in Congress may provide some breathing space, but the relief will only be short term. Meanwhile, the world is staying tuned and desperately hoping that Uncle Sam can come up with the right solutions.