US President Barack Obama says Democrat and Republican leaders have reached an agreement on reducing US debt, before the August 2 debt ceiling deadline.
Failure to reach a deal may have led to a historic US default.
The agreement, which still has to be voted on by both the Senate and House of Representatives, involves government spending cuts of just under US$1 trillion over the next ten years, with additional longer term cuts of US$1.5 trillion to be found by a special committee.
We asked some leading economists whether this agreement resolves the debt crisis, if a ratings downgrade may still happen, what the consequences will be for the Australian dollar and where the cuts may come from.
Saul Eslake, Program Director at the Grattan Institute
It reminds me of a quote from Winston Churchill that I’ve used in this context: “You can rely on the Americans to do the right thing after they’ve tried everything else.” It does now seem particularly apposite in this context.
It might not be enough, especially given the lack of detail, to prevent a downgrade of the US credit rating, particularly by Standard & Poor’s who seem to have been more assertive about this than Moody’s and Fitch. In which case, some of the consequences that have been spoken of – the higher long-term interest rates and the lower US dollar – may still come to pass to some extent.
But because they have agreed, as I understand it, to increase the debt ceiling by enough to ensure the debt doesn’t become an issue again anytime soon, then the risk of precipitating another financial crisis, or of a steep decline in the US economy and hence potentially in the global economy, would seem to have been averted.
In very short term, it will probably mean a rebound in the US dollar. Hence, the Australian dollar will give up some of its gains in the last week or so which has taken it up to US$1.10. Say 2 and 4 cents in each case.
If over the next week or so the rating agencies or at least one of them, does downgrade their rating – I’m not saying they will – then that could see the US dollar resume its downward trajectory and the Australian dollar resume its upward one.
The other thing to consider – and I don’t think we can make a judgement about this until we see more of the detail and whether what’s been agreed actually gets implemented – is what impact measures designed to cut the US deficit substantially will have on the US economy.
We learnt on Friday the US economy has been weaker in the first half of this year than previously thought, because previously reported growth for the first quarter was revised down substantially and initial reported growth for the second quarter was weaker than expected. So the US economy is not in a strong position to absorb big cuts in government spending.
As a percentage of US GDP, which is running at about $15 trillion per annum, the cuts are a lot. Given that government spending has been one of the handful of things keeping the US economy afloat since the recession officially ended, there could be some significant consequences for the health of the US economy in the short term.
I don’t dispute they have got to do something long term. But whether doing as much in the very short term can be done without adverse consequences for the US economy in the short term – that’s something markets will given consideration to.
Presumably cuts will be made in things sacred to the Democrats, such as social security and Medicare. If they’re made in areas such as defence and agricultural subsidies, hurray, because a lot of that expenditure is wasteful, particularly when it comes to farm subsidies. Any reduction in US spending would be welcomed by Australians.
I simply don’t know if those areas will be targeted or whether it will be somewhere else, but the bulk of federal US spending is on cash payments to individual either pensions or payments for healthcare and defence.
And interest – they pay something like a quarter of a trillion dollars in interest, but they obviously can’t cut that before they cut the debt.
Yes, they spend some money on education and a little bit on transport and things like that … They supposedly spent a trillion dollars on aviation security in the past decade – they could certainly cut a lot of that and no one would be worse off. I hope they do and I hope Australia follows their example and cuts our wasteful spending on airport security.
Sam Wylie, Associate Professor at Melbourne Business School
This is, of course, a preliminary deal. President Obama, House Speaker Boehner and the Republican Senate leader Mitch McConnell and the Democrat Senate leader Harry Reid have agreed on the deal, but my understanding is that Democratic House Minority Leader Nancy Pelosi wasn’t in on the negotiations.
So while there is an agreement among the party leaders, the deal still has to make it through the House of Representatives, which is in a much more fractious state than the Senate.
Whether this will actually lead to a bill making through the House is not at all obvious at this point.
But if it does succeed, it looks like a small win for the Tea Party, which seems to be driving the train of the Republicans at the moment. I say that because the deal includes some pretty serious cuts, amounting to US$2.5 trillion – which is much more than was being discussed even just a few months ago.
Also, it doesn’t include any triggers for tax increases. So they’re going ahead with a US$900 billion increase in the debt limit with a matching US$917 billion cut in spending. That could have really been agreed to some time ago.
The second part of the agreement adds another US$1.5 trillion in spending cuts, which have to be agreed to by the Thanksgiving weekend at the end of November.
If those additional cuts are not agreed to, and they can’t get a bill to Congress before Christmas, then automatic cuts to everything to all expenditure apart from social security will come in.
What the Democrats wanted here was a deal that took them beyond the next presidential election in 2012. They’ve gotten that. But what the Republicans wanted was this trigger point whereby if they can’t agree on the next round of cuts, then there will be automatic cuts in spending rather than increases in taxes.
The Republicans therefore have a deal that will get the party to agree in the House because there is nothing about new taxes in it. That’s why I see it as a small win for the Tea Party.
This stand off has been, of course, highly political. But I don’t think there was any way around it. They are genuinely going close to the wire here. They probably had another couple of weeks to play with, but this is going genuinely close to a default.
I don’t think anybody is being inauthentic, or whimsical or ephemeral here. This is not about small issue. There is a genuine dichotomy in the US about big government and small government.
The Tea Party really does believe that the state is the Leviathan. They see it as a great, swollen interfering beast and they want to shrink it by starving it.
Meanwhile, the Democrats genuinely do believe that in role of the state to help ordinary Americans to make their lives better. They believe in a bigger role for the government, even though of course the US government is much smaller, by comparison, than most European governments.
This is not a dispute about something small. It is a showdown in Washington over an issue that has been a long time in the making. It’s been a dispute ever since President Roosevelt through the New Deal, and of course during the Second World War, put the US on the path towards bigger government.
A showdown like this has been looming for a long time. The surprising thing is not that this showdown has come, but that it has come on so suddenly. It has always been inevitable, because if you don’t have taxes and you go have spending increases then something is going to have to give. You’re inevitably going to have a showdown between these two visions.
Martijn Konings, Lecturer in Political Economy, US Studies Centre, University of Sydney
It isn't surprising they came up with this last-minute deal because there was a lot pressure on Democratic and Republican leaders to avoid default. Not all the details are entirely clear or out in the open, and it seems to leave a lot of major issues to be dealt with in the future. So it's quite hard to figure out who the winners were in this process.
For Obama, the major benefit is that some controversial issues will be pushed out until the next election. But the imposition of these austerity measures on his administration means it will be much harder for him to pursue some of his key political commitments in the next few years. So that’s a significant blow.
The Republicans appear to have gotten more of what they wanted, but at the same time, there appears to be a quite a significant risk of major cuts to the military, which is surprising and not something the Republican leadership will be happy about.
And this speaks to the tremendous influence of the Tea Party. Republicans leaders initially thought they could harness this movement to their own purposes, and now they realise they are not quite as capable of controlling it as they thought they were. It has forced them to pursue options they're probably not all that thrilled about.
So in terms of traditional political lines of division, things have gotten quite confusing.
The immediate emergency has been dealt with, but the politics around this issue are likely to start again in full force at a later date.
I was surprised to see that cuts to Medicare and social security aren’t deeper than they seem to be, but the way the debt reduction process is set up it seems that this could still happen at a later point.
The longer-term issue is that Republicans have discovered they have a legal instrument they can use to exact major concessions. This could remain an issue for years to come, and there is no reason the Democrats won’t use it on a Republican president in turn.
The debt ceiling has become extraordinarily politicised, and the effects of this will be quite unpredictable. After all, the political debate in the US has a way of making quite dramatic turns (just a couple of years ago politicians were talking about the need to regulate Wall Street and now everyone is concerned about the massive size of government).
There is a risk that the US dollar will suffer from this in the long run.
Groups like the Tea Party and Americans for Tax Reform now have a tremendous sense of their own influence, so in that sense the current situation represents something of a populist victory. But it’s hard to say there have been any real winners here.
It’s been a great deal of political theatre that has gotten out of hand, and I don’t think it has done anyone any good.