When it comes to US government debt deals, the battle, in the words of legendary New York Yankees baseball coach Yogi Berra: ‘Ain’t over til it’s over’.
Financial markets may breathe a huge sigh of relief that a bitterly divided House of Representatives has managed to trim the Biden Administration’s spending commitments by $1.32trillion (£1.1trillion) and averted a default.
US Treasury Secretary Janet Yellen warned that if a deal was not done by June 5 (Monday), the almighty American government would hit the $31trillion (£25trillion) legislated ceiling on the levels of national debt. It would no longer be able to pay the enormous interest and be in default.
That, it was feared, would cast the US as a pariah state on markets – joining such outliers as Argentina and Sri Lanka – leading to a calamitous fall in its credit rating.
If faith in American treasuries or bonds were to be undermined – they are held in the reserves of countries across the globe – it could unleash a tsunami every bit as damaging as the financial crisis of 2007-09.
Agreement: Joe Biden and Kevin McCarthy (inset)
Such a catastrophe has been averted and anyone following America’s heated deficit and debt debates down the decades will know strong elements of political brinkmanship were involved, with a presidential election looming in 2024.
It is no accident that the deal finalised by the House, with the agreement of President Biden on Thursday, expires after the election – a problem for the next occupant of the White House.
And it could be unpicked in the Senate. All it would take is one renegade Senator to filibuster and hold matters up at the weekend to provoke a fresh crisis.
America’s debt problem didn’t just happen. The debt-to-national-output ratio of 123.4 per cent of GDP is a legacy of former President Trump’s Covid spending and Joe Biden’s fiscal largesse.
Under Biden, the US budget deficit has swelled by $4.8trillion (£3.9trillion) or, to put it another way, two years of Britain’s total output. Labour shadow chancellor Rachel Reeves avoided discussing the arithmetic in her Washington speech on May 24, praising the Biden Administration for ‘rebuilding economic security, strength and resilience’.
One can understand why Labour is keen to align with a second-term Biden Administration. Instead, she criticised Chancellor Jeremy Hunt for accusing the Americans of being engaged in a ‘distortive global subsidy race’. That is precisely what the US Chips and Science Act and the misnamed Inflation Reduction Act are designed to do.
Barely a day passes without UK firms such as Scottish battery maker AMTE or power firm Drax saying they are planning to move some production to the US.
Biden’s intentions may be noble, making progress on green energy and lessening dependence on China for semiconductors, but the impact is that of a giant magnet pulling in investment.
Britain can stretch its balance sheet using subsidies, loan guarantees and other measures to attract green investment. But fragile public finances, which are once again pushing the yield on government bonds (gilt-edged stock) into the danger zone, prevent Rishi Sunak’s Government or a future Labour administration competing effectively with the US. Usually, global markets can ignore America’s fiscal largesse because the dollar enjoys the privilege of being the world’s reserve currency.
That allows it to print more or issue more US Treasury stock because there is always a big surplus country (paradoxically, China is the largest) with little choice but to hold dollar reserves.
In many ways, the US deal looks like a setback for conservative Republicans who hoped to roll back Biden’s big-spending ways. House Republicans, led by Speaker Kevin McCarthy, had a target of up to $4.63trillion (£3.7trillion).
Amid the rancour, there were minor victories. Funding for the Internal Revenue Service over the next decade has been lowered by $21.4billion (£17.3billion) from $80billion (£64.5billion). Republicans raised fears of an intrusive army of tens of thousands of new tax staff poking into every aspect of people’s lives. In reality, the complaints were less about loss of privacy and freedoms and more about the likelihood that, with better IT tools and more staff, the IRS would be better able to tackle avoidance and evasion.
Mostly, the cuts or savings will come from discretionary spending – the military budget, funds for war veterans’ health and social security (pensions) are fully protected.
Efforts to overturn plans to cancel $460billion (£371billion) of student loans failed. The deal looks a political no-score draw, although Biden and the Democrats may have won on penalties. It contains the debt panic but does little to end the deficit and debt Everest. The longer-term concern is that it will be much harder to lower inflation and could mean higher interest rates for longer.
Elevated borrowing costs could constrain growth in the world’s most resilient advanced economy.
That cannot be good for prosperity across the globe.
