US debt deal may be too little, too late

The fight to save the US's AAA rating is just beginning, with huge implications for the global economy

Like university students with an essay crisis, members of the United States Congress wired up on Red Bull and coffee worked through the night on their plan to cut the country's indefinitely rising national debt. As The Independent went to press, it looked like they were on course to slip their work under the professor's door by daybreak, averting the default that financial markets always thought was unthinkable. The question, with these last-minute rush jobs, is whether the finished work can possibly get a good grade. And it will be graded.

Is it an AAA piece of work? The professors at the credit-rating agencies have their marking pens poised. Standard & Poor's had already put the US on notice that it is as likely as not to strip the US of its AAA credit rating in the weeks ahead; Moody's said last month that while a default would definitely lead to a downgrade, it was also conducting a wider review of American sovereign debt and the safety of US Treasury bonds.

On the one hand, it might seem extraordinary that the world's largest economy – whose dollar is the world's reserve currency and whose government bonds are used throughout the banking system as a proxy for cash – will be dumped from the elite group of nations whose debt is considered risk-free. On the other, after the shenanigans of the past few days, who can say with a straight face that there is no risk of the US defaulting on its obligation to pay its creditors?

"I am even more convinced a downgrade is coming today than I was yesterday or the day before," said Paul Dales, US economist at Capital Economics in Toronto. "The package that looks to be coming through now falls well short of what is needed. It just depends on whether S&P pulls the trigger this week or later in the year, and what tends to happen is that when one rating agency goes, others tend to follow."

The Budget Control Act of 2011, should it be passed, authorises the federal government to borrow the money it needs to pay its bills, including interest payments to bondholders. It also sets spending caps to reduce government spending by $917bn from what is currently projected over the next 10 years. There will be a further $1.2-$1.5trillion in deficit reduction, either via vicious spending cuts across all departments or from a bipartisan agreement to start tackling long-term problems such as spiralling healthcare spending on baby-boomer retirees and under-taxation.

S&P was staying mum yesterday. It has refused to give a running commentary on the different proposals being thrashed about in Congress, but what is clear is that the current deal falls short of the optimal outcome that the agency said would definitely safeguard the AAA rating. That was a $4trn deal that included some work to tackle long-term issues. Here is what the agency's John Chambers, who will make his recommendation to S&P's sovereign-rating committee soon, wrote last month: "We may lower the long-term rating on the US by one or more notches into the AA category in the next three months if we conclude that Congress and the administration have not achieved a credible solution to the rising government debt burden and are not likely to achieve one in the foreseeable future."

As Peter Orszag, the Obama administration's first budget director, now a Citigroup vice chair, wrote in an essay for Foreign Affairs journal, "rising healthcare costs are at the core of the United States' long-term fiscal imbalance. It is no exaggeration to say that the US's standing in the world depends on its success in constraining this healthcare costs explosion." He is echoing the repeated words of Ben Bernanke, chairman of the Federal Reserve, and countless economists.

The federal debt has ballooned from a historically average 40 per cent of GDP in 2008, before the ill effects of the financial crisis and the Great Recession, to 70 per cent by the end of this year. Why? The size of the economy is smaller than it was before the downturn, tax receipts on this shrivelled base are lower, public spending has reset higher as unemployment benefits have kicked in, and there was a $787bn stimulus package, too, in 2009.

All together, the ageing of the population and the rising cost of health care would cause spending on the major mandatory healthcare programmes and Social Security to grow from roughly 10 per cent of GDP today to about 15 per cent of GDP 25 years from now, the independent Congressional Budget Office calculates.

These mandatory programmes, though, have been punted to a new bipartisan committee, which will suggest long-term tax and spending changes to Congress for a vote around the Thanksgiving holiday in November. If that vote fails, rolling reductions in discretionary spending, including deep cuts at the Pentagon, will ensure an outcome that the White House hopes will spur Republicans into accepting some tax rises as part of a bipartisan deal.

These are the complex issues that S&P, Moody's et al must grapple with. And there is one more. The CBO's debt predictions for the US government are based on assumptions of economic growth over 3 per cent each year well into the second half of the decade. But the GDP figures for the first half of 2011 show the economy performing at below 1 per cent; yesterday's manufacturing figures showed orders have started shrinking; and economists are scaling back their hopes of a gradual decline in unemployment, which is stuck above 9 per cent.

The US finances, already shaky, look weaker by the day.

The Ratings Conundrum

When a country loses its elite status as an AAA-rated nation, financial markets usually take the development in their stride. Economic historians have been scouring the data for parallels as a possible US downgrade looms, and have helped soothe investor concerns. When the US's northern neighbour was cut in 1995, there was no market rout for the Canadian currency, its stock market or for government bonds. Interest rates rose, but incrementally over several weeks, and the government was able to restore its AAA rating after a dose of austerity and market liberalisation.

When Japan lost its top-notch rating from Moody's in 1998, the yen fell less than 1 per cent, while economists attributed a subsequent drift upwards by Japanese interest rates to signs of astirring economy, rather than a bond investors' strike. Research by AllianceBernstein, the investment bank, found insignificant changes to interest rates for all the governments to have lost AAA status since 1990.

The lesson is that global markets are perfectly able to accommodate a patchwork of different sovereign credit ratings around the world.

There is a difference this time, of course, namely the importance of US Treasuries to the plumbing of the financial system, but the consequences of a rating change are hard to predict.

As Howard Wheeldon, analyst at BGC Partners, said yesterday: "Events on Capitol Hill this week confirm another border may now have been crossed – one that suggests the world has changed and that life may never be the quite the same again."

Start your day with The Independent, sign up for daily news emails
News
peoplePair enliven the Emirates bore-draw
Arts and Entertainment
tvPoldark episode 8, review
News
Britain's opposition Labour Party leader Ed Miliband (R) and Boris Johnson, mayor of London, talk on the Andrew Marr show in London April 26
General electionAndrew Marr forced to intervene as Boris and Miliband clash on TV
Arts and Entertainment
Ramsay Bolton in Game of Thrones
tvSeries 5, Episode 3 review
ebooks
ebooksA special investigation by Andy McSmith
  • Get to the point
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Ashdown Group: Treasury Assistant - Accounts Assistant - London, Old Street

£24000 - £26000 per annum + benefits : Ashdown Group: A highly successful, glo...

Ashdown Group: Business Analyst - Financial Services - City, London

£50000 - £55000 per annum: Ashdown Group: Business Analyst - Financial Service...

SThree: Trainee Recruitment Consultant

£18000 - £23000 per annum + OTE £45K: SThree: At SThree, we like to be differe...

SThree: Trainee Recruitment Consultant

£20000 - £25000 per annum + competitive: SThree: Did you know? SThree is the o...

Day In a Page

Not even the 'putrid throat' could stop the Ross Poldark swoon-fest'

Not even the 'putrid throat' could stop the Ross Poldark swoon-fest'

How a costume drama became a Sunday night staple
Miliband promises no stamp duty for first-time buyers as he pushes Tories on housing

Miliband promises no stamp duty for first-time buyers

Labour leader pushes Tories on housing
Aviation history is littered with grand failures - from the the Bristol Brabazon to Concorde - but what went wrong with the SuperJumbo?

Aviation history is littered with grand failures

But what went wrong with the SuperJumbo?
Fear of Putin, Islamists and immigration is giving rise to a new generation of Soviet-style 'iron curtains' right across Europe

Fortress Europe?

Fear of Putin, Islamists and immigration is giving rise to a new generation of 'iron curtains'
Never mind what you're wearing, it's what you're reclining on

Never mind what you're wearing

It's what you're reclining on that matters
General Election 2015: Chuka Umunna on the benefits of immigration, humility – and his leader Ed Miliband

Chuka Umunna: A virus of racism runs through Ukip

The shadow business secretary on the benefits of immigration, humility – and his leader Ed Miliband
Yemen crisis: This exotic war will soon become Europe's problem

Yemen's exotic war will soon affect Europe

Terrorism and boatloads of desperate migrants will be the outcome of the Saudi air campaign, says Patrick Cockburn
Marginal Streets project aims to document voters in the run-up to the General Election

Marginal Streets project documents voters

Independent photographers Joseph Fox and Orlando Gili are uploading two portraits of constituents to their website for each day of the campaign
Game of Thrones: Visit the real-life kingdom of Westeros to see where violent history ends and telly tourism begins

The real-life kingdom of Westeros

Is there something a little uncomfortable about Game of Thrones shooting in Northern Ireland?
How to survive a social-media mauling, by the tough women of Twitter

How to survive a Twitter mauling

Mary Beard, Caroline Criado-Perez, Louise Mensch, Bunny La Roche and Courtney Barrasford reveal how to trounce the trolls
Gallipoli centenary: At dawn, the young remember the young who perished in one of the First World War's bloodiest battles

At dawn, the young remember the young

A century ago, soldiers of the Empire – many no more than boys – spilt on to Gallipoli’s beaches. On this 100th Anzac Day, there are personal, poetic tributes to their sacrifice
Dissent is slowly building against the billions spent on presidential campaigns – even among politicians themselves

Follow the money as never before

Dissent is slowly building against the billions spent on presidential campaigns – even among politicians themselves, reports Rupert Cornwell
Samuel West interview: The actor and director on austerity, unionisation, and not mentioning his famous parents

Samuel West interview

The actor and director on austerity, unionisation, and not mentioning his famous parents
General Election 2015: Imagine if the leading political parties were fashion labels

Imagine if the leading political parties were fashion labels

Fashion editor, Alexander Fury, on what the leaders' appearances tell us about them
Phumzile Mlambo-Ngcuka: Home can be the unsafest place for women

Phumzile Mlambo-Ngcuka: Home can be the unsafest place for women

The architect of the HeForShe movement and head of UN Women on the world's failure to combat domestic violence