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Debt as Bargain Counter

The agreement in the United States on raising the debt ceiling that was reached at the last minute need not have been a cliffhanger. The broad contours of a deal and whose interests it would serve were known for some time. However, it could be a pyrrhic victory for the powerful financial sector. The downgrade of US debt by one rating agency does not change anything.

HT PAREKH FINANCE COLUMN

the need for deficit reduction, but wanted

Debt as Bargain Counter

to ensure that it did not come solely through spending cuts but also from tax increases. Reasonable, most would argue, C P Chandrasekhar given the sharp increase in inequality in

The agreement in the United States on raising the debt ceiling that was reached at the last minute need not have been a cliffhanger. The broad contours of a deal and whose interests it would serve were known for some time. However, it could be a pyrrhic victory for the powerful financial sector. The downgrade of US debt by one rating agency does not change anything.

C P Chandrasekhar (cpchand@gmail.com) is with the Centre for Economic Studies and Planning, Jawaharlal Nehru University, New Delhi.

I
n a political move that risks a crisis in global financial markets, ratings major Standard & Poor’s (S&P) has downgraded US debt to AA+ status for the first time. American government paper has lost its hitherto unassailable AAA standing and had its long-term outlook declared negative. Even if this does not make a difference in the medium term, it can in the short run impact interest rates and destabilise markets. So the question is: Why did a firm like S&P, which was discredited during the 2008 crisis and is by no means “independent” of financial interests, make this move? Clearly, even if it had overstepped its brief, its action does represent a push on the part of finance to rein in the State, even in the US. That seems to be the message from the debate over the level of US debt as well.

Despite the media’s sensational reporting, everybody knew that the stand-off over the US public debt ceiling was no cliffhanger. The issue involved was rather straightforward. Under a rule introduced in 1917, the US Congress has to set a ceiling on government borrowing, which only Congress can revise. Since the government’s borrowing requirements inevitably rise with changes in economic circumstances, the ceiling has been periodically revised and stood at $14.3 trillion until the recent deal. The US government had hit that ceiling in May and needed to have it revised upwards if it was to continue meeting its expenses and servicing its debt.

Under normal circumstances this would have been routine, but the Republicans, who have a significant majority in the House of Representatives chose to use Congress authorisation as a bargaining counter. They converted the debt ceiling discussion into an attack on the government’s “excessive” budget deficit financed with that debt, and demanded spending cuts that would reduce the deficit over time. The Democrats did not really challenge

august 13, 2011

the US, with huge gains in disposable incomes accruing to the top 1% that had benefited from the tax cuts under President George Bush. But the Republicans would have none of that, leading to the stand-off that threatened to make the US government a defaulter.

Rise in Debt-GDP Ratio

Any default on payments by the US government would have damaged banks holding such debt to an extent that might have spelt insolvency. The US government has just pumped in a huge volume of public resources to save its banks from a collapse that would have been of their own making. That, together with the stimulus to deal with the crisis, was largely responsible for taking America’s net debt-to-GDP ratio from 42.6% in 2007 to 72.4% in 2011. The government was unlikely to drive them to insolvency soon thereafter.

There is also the fact that notwithstanding Republican views on public debt, it could hardly be argued that America’s debt levels are alarming. Though it amounts to close to a third of the global total, US public debt is by no means too high relative to its GDP to warrant excessive concern. There are at least 10 advanced economies, from debt-strapped Greece to conservative Germany, that record a higher net debt-to-GDP ratio.

Moreover, damaging financial institutions by devaluing public debt would hurt the financial interests that fund most representatives elected to Congress. Those interests would hardly let Congress get away with a partisan stand-off between a Republican majority house and a Democratic president that dramatically erodes their profits and damages the value of their assets.

Why then did the stand-off occur? Essentially because the Republicans, under pressure from their own right wing, decided to use their House majority to hold the government to ransom and push for the adoption of policies that are being espoused by them. Financial

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Economic & Political Weekly

HT PAREKH FINANCE COLUMN

interests in the US, which seem to wield final power, decided to play along and even spread alarm by talking about defaults and downgrades, because central to the demands made by the Right were policies that serve the interests of finance capital.

Consider for example the compromise package that came out of the negotiations on the relaxation of the debt ceiling. In the last minute “deal” President Barack Obama has been authorised to increase the debt limit by at least $2.1 trillion. In return there is to be immediate action to cap spending so as to reduce the deficit by $1 trillion, and the creation of a bipartisan committee that would identify ways of cutting expenditure to realise an additional $1.5 trillion reduction in the deficit.

Serving Finance

There are at least three elements in this package that serve the interests of finance. One is the decision to curtail the US fiscal deficit, currently placed at around 9% of GDP. Having pushed for the substitution of private with public debt to resolve the banking crisis and having allowed the deficit to widen, finance capital now feels it is time to reduce the fiscal deficit and the level of public debt to foreclose any possibility of sovereign default in the future. To that end they set their demands quite high. S&P, for example, was recommending a $4 trillion reduction in the deficit, which it argued is needed for debt sustainability. It was disappointed that the Republicans managed to extract only a $2.5 trillion reduction.

A second element of the agreement is that the reduction in the deficit is not to be realised through any increase in taxes, but through spending cuts. It is obvious that finance capital would be keen on preventing new taxes or the withdrawal of any previously won tax cuts, including those garnered under the Bush administration, which should have expired. It has had its way. Estimates of corporate profits during the stimulus years 2009 and 2010 have recently been revised substantially upwards and the financial sector accounts currently for close to a record one-third of profits. Yet, as of now deficit reduction will not come from resources mobilised through direct taxation. The Democrats

Economic & Political Weekly

EPW
august 13, 2011

have just about managed to ensure that the areas in which much of these spending cuts are to occur are left open and Medicare and social security are not severely damaged in the first round of cuts.

But the danger that such damage would occur is real. In the 10-year discretionary spending caps that are to be immediately enacted to reduce the deficit by $1 trillion, there is to be a balance in distribution between defence and nondefence spending. This means that the cuts that would be made would also be balanced across defence and nondefence expenditure. Since taxes cannot be increased, interest payments on past debt cannot be avoided and defence should not be too severely axed, the large expenditure cuts planned will erode social spending. This is the third element that suits finance.

All this is to occur when the evidence points to a further slowing of growth and the persistence of high unemployment in the US. While the unemployment rate stood at 9.2% in June, figures released on the day the deal was signed pointed to a stagnation in incomes that month and a fall in consumer spending for the first time in two years. The economy has grown by just 0.8% during the first half of 2011. Growth slowed soon after the stimulus was withdrawn. This would point to the need for stepping up government expenditure to improve growth, reduce unemployment and revive the real economy. Choosing to cut expenditure sharply at this point in time could deliver the second of the downturns expected by economists who feared a double-dip.

Clearly then, the package purely serves the interests of finance. But in time these measures may prove short-sighted even from the point of view of finance. Abjuring tax increases and cutting spending and growth could reduce government revenues significantly. As a result the deficit may persist and widen even with the spending cuts. Finance may not r ealise its deficit-reduction objective while the economy may go into a tailspin. That would not be good for financial profits either.

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vol xlvi no 33

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