The US budget remains in the spotlight for financial markets, with negotiations over the fiscal cliff and the government debt ceiling still a long way from being resolved.
The two issues are increasingly intertwined, with Republican House Speaker John Boehner referring to plans to increase income tax on the wealthy as "silliness” and saying that the talks to find a compromise had gone "almost nowhere”. This is despite the increasing urgency to find a compromise, with the absence of a solution to the fiscal cliff threatening to see the US dip back into recession.
US Treasury Secretary Timothy Geithner, who is advocating President Obama’s plans for a range of spending cuts and a tax hike on those with an annual income of more than $US250,000 a year, has made it very clear that "there is not going to be an agreement without [tax] rates going up”.
If there is no compromise on the fiscal cliff, which involves a series of automatic spending cuts and broadly based tax increases, there will be a king hit of around $600 billion cut from the still fragile US economy from January 1, 2013. This is over 4 per cent of GDP and would be an untenable jolt to the economy which is still only growing at a moderate 2.5 per cent pace and where the unemployment rate is still around 8 per cent.
While the negotiations over the fiscal cliff continue, the US government debt ceiling is rapidly moving into focus.
The US will bump up against its $US16.4 trillion government debt ceiling within weeks. Unless Congress agrees to raise it by around the end of January 2013, the US will potentially be unable to pay wages, health providers, defence contractors and the like and in a worst case, it would effectively default on its debt (although this is extremely unlikely).
Debate and dispute between Congress and President Obama about raising the debt ceiling could be heading for a rerun of the dramas of 2011. In August of that year, when the hostile Congress prevaricated over the Obama Administration’s need to raise the debt ceiling, the US stock market slumped more than 5 per cent in a day and credit rating agency Standard & Poor’s downgraded the US government credit rating from triple-A. S&P cited the budget impasse rather than the level of government debt as the main reason for the downgrade.
The Republican’s willingness at that time to take the government debt requirement to the brink and to use its numbers in Congress to threaten the same again now, sits oddly with the history that shows the Reagan administration increased the debt ceiling six times, George Bush senior raised it twice, Clinton three times and George W Bush six times. Most of these decisions to raise the debt ceiling occurred with little fuss and fanfare. There was too much at risk to play political games with the issue of the government not paying its bills and being unable to pay back bond holders. Congress was an effective rubber stamp for what was, until recently, a largely procedural issue. It would have been a form of economic treason, without being too melodramatic, if the US economy was threatened by a hostile Congress trying to use the debt ceiling as leverage for political reasons.
But this is no longer the case.
In additional to the fiscal cliff impasse, Boehner is trying to link Congressional agreement to raise the debt ceiling to spending cuts that the Obama administration does not want to deliver. Boehner said, "any increase in the debt limit has to be accompanied by spending reductions that meet or exceed it".
In a Tea Party style approach to the debt ceiling, Boehner said "what do you think would happen if we gave the president $US1.6 trillion of new money? He’d spend it!”
All of which highlights the fragile position of the fiscal cliff and debt ceiling discussions at the moment. Time is fast running out for posturing and most sensible analysts suggest that a mix of some spending cuts and tax increases is the best way to approach the problems of the US budget deficit. Common sense also suggests a measured phasing in of these policies to avoid the potentially harsh effects of the fiscal cliff and for the debt ceiling to be raised, without fuss or bother.
If the fiscal cliff hits the US economy and the debt ceiling is not raised, there could be a rerun of the market debacle and volatility that hit in 2011. It seems odd that the Republicans are will to risk this, especially after being so soundly beaten in last month’s elections.