Cause and Effect in European Politics and Law

The US default is postponed ... for now

Adelina Marini, August 4, 2011

After heart-breaking negotiations that lasted more than a month, literary in the 59th minute of the 11th hour President Barack Obama signed into law the agreement that would allow the government to raise the debt limit by $2.1tn. Alas, the compromise agreement only postpones the risk of a short-lived default with several months. In return for the raising of the debt brake the White House committed to reduce the budget deficit by $1tn in the next 10 years. Most threatened by the big scissors is the defense sector, the budget of which grew exponentially in the last 10 years because of the two wars the US has started in 2001 in Afghanistan and in 2003 in Iraq.

In the meantime a temporary committee in Congress will be established which has to come up with a proposal by November for additional reduction of the deficit by $1.5tn. If the committee fails to achieve an agreement how to reduce the deficit with additional $1.5tn, the agreement will trigger automatic spending cuts as of 2013. The most basic social programmes like Social Security, Medicare and low-income programmes will be spared from the cuts.

As the Senate leader of the Democrats Harry Reid put it, this was a typical compromise agreement - when no side got what it wanted.

Who wanted what?

The Republicans insisted on bolder spending cuts, including social programmes, The Democrats, however, were firmly against social programmes to be touched in a moment when economy is recovering with disappointing pace and unemployment is still high - 9%. In order the budgetary loopholes to be filled the Democrats proposed increases of revenues through abolishment of the tax reliefs for the richest Americans, agreed during the two terms in office of President George W. Bush. The Republicans, though, were firmly against any increases of the tax burden for the rich Americans. And most stubborn of them were the representatives of the Tea Party.

And the White House was cautious on making strident movements in the year before the presidential elections in which Barack Obama will fight for a second term.

In a statement after the voting in the Senate the Republicans pointed out that although not perfect, the legislation was a good sign that "Washington is beginning to move in the right direction to get spending under control and our economy back on track. Obama was dragged kicking and screaming to the negotiating table as Republicans once again changed the conversation away from his agenda of higher taxes and more spending".

Minutes after he signed the agreement into law President Barack Obama made an 8-minute statement, entitled Putting Americans Back To Work. In his speech he sounded supra-political and played the role of a unifier. "In the last few months the economy has already had to absorb an earthquake in Japan, the economic headwinds coming from Europe, the Arab spring and the oil prices all of which have been very challenging for the recovery. But these are things we couldn't control. Our economy didn't need Washington to come along with a manufacture crisis to make things worse. That was in our hands", Obama said.

Without naming anyone in particular Barack Obama emphasized that voters might have elected a divided government but they certainly had not voted for a dysfunctional government. In his words the main task which Congress has to deal with after the recession is extending tax cuts for the middle class families, improving business environment, tax burden sharing on behalf of the oil and gas companies in a fair way, as well as abolishing the subsidies for rich Americans.

"Both parties share power in Washington and both parties need to take responsibility for improving this economy. It is not a republican responsibility, it is not a democratic responsibility, it is a collective responsibility as Americans", Mr Obama concluded.

The voice of the voters

And while Washington was gripped in a heavy partisan skirmish, most Americans demonstrated loathing with the partisan games on such an important issue in the numerous polls, which the big media were holding all the time in an attempt to reason the politicians. The most interesting in a national poll from mid-July was that the Tea Party supporters were among the most disappointed from the behaviour of their representatives. According to the data, quoted by The New York Times, 66% of the supporters of this group, which is not yet a separate party but a fraction within the Republican party, had stated that a compromise needed to be found with the Democrats.

31 percent of the respondents insisted the Republicans should not to step aside from their positions even if that meant no agreement, i.e. a default of the government. And to the key question whether in the debt limit agreement tax increases should be included, only spending cuts or a combination of both, the majority or 53% responded with a combination of both - tax increases and spending cuts.

According to the respondents the debt must be reduced but first it must be ensured that the economy will recover fully and will start generating new jobs.

Obviously Barack Obama's speech after the Senate approval targeted precisely these voters. "We need to begin by extending tax cuts for middle class families. So that you have more money in your paychecks next year. If you've got more money in your paycheck you're more likely to spend it and that means small businesses, and medium-sized businesses and large businesses will all have more customers. That means they will be in a better position to hire".

According to economic analysts the disappointing data for the economic activity in the first and second quarters of this year are due to the low domestic consumption, which represents 70% of the GDP.

For a rating no one needs?

One of the main fears during the debt limit negotiations was that if default were allowed that would bring a crash of the country's credit rating which, on its part, would doom economic recovery to death. According to The New York Times the excellent credit rating (triple A) is a now rarity in business. Moreover, it is an anachronism. Tens of big corporations had lost their AAA status in the past years and only four non-financial companies still maintain this high rating because, as many consumers relied on their credit cards to sustain a high standard of living, many companies as well took more debt on in order to ensure bigger returns.

According to the newspaper, the investors do not see a big difference between companies with triple A rating or a level below that. "It’s like you are going from a Rolls-Royce to a Mercedes — not from a Rolls-Royce to a Yugo," said Chris Orndorff, a senior portfolio manager for the bond giant Western Asset Management. For now the three big credit rating firms keep the excellent rating of the US but on Tuesday Moody's announced its outlook was negative. Fitch said it planned to complete its review of government finances by the end of the month and Standard & Poor's warned that the United States could lose their rating unless they reduced the deficit significantly.

Although the assessment of countries is based on many factors, the main one remains trust. And it was trust that suffered a great lot during the 1-month theatre up to the achievement of a mega short-term agreement aimed at postponing the American default.