Why the Debt Deal Will Hurt America and Obama

"The Third-Term Panic", by Thomas Na...Image via Wikipedia
And why the rest of the world has to absorb the mess!

At the last minute, before the August 2nd deadline, Congress voted to increase the debt ceiling, just enough to avoid government shutdown, and worse for America's reputation, downgrading of its debt by the now infamous rating agencies, Moody's, Fitch and S&Ps.

Yet the debt deal between President Obama and the Republican-led Congress was anything but satisfactory: according to a new CNN poll (released on 2 August), it has left most Americans (77%!) disgusted with their political class. And going beyond public opinion and looking at the reality of the situation, it has left unsolved all the essential problems besetting the American economy, while seriously threatening Obama's chances at re-election in 2012.

The plan just approved in Washington is anything but straightforward. Instead of the $4 trillion savings the rating agencies wanted to see implemented, there's just an  initial savings of $917 billion and perhaps another $1.5 billion by the end of the year, based on recommendations of a bipartisan joint House and Senate committee - a committee of 12 sages (!). If not, then automatic across-the-board spending cuts would kick in.

First, the economy. How will the debt deal hurt it? Remember the economy is already in slowdown mode. The Great Recession may be over (although that's debatable) but unemployment remains the number one problem with nearly 15 million people unemployed. Trouble is: the debt deal is mum on this point. Not a word. It's all about cutting the deficits, finding more savings and raising taxes. And, as we all know, cutting government expenditures means drawing down on activities in the service industries and sending civil servants home. Net result: more unemployment, more pain.

This is a repeat of History, when President Roosevelt tried to curb the deficit in 1937 and the economy plunged back in recession. It took World War II spending to finally take America out of the Big Depression.

The American political system appears to be acutely dysfunctional at present. The historic polarization of American society, traditionally divided between Republicans and Democrats, has taken a turn for the worse recently, with the Republicans lurching to Tea Party extremes. Just take a look at the two books I attached below: they couldn't be further apart in their ideological positions. And the latest news is that the Senate failed to authorize refinancing of the Federal Aviation Administration (F.A.A.): this means that for another month at least, airport inspectors won't be paid and are asked to work out of the goodness of their heart to ensure airport safety!

Is that a serious way to run a democracy? At the expense of citizens' safety?

Second, Obama. On the face of it,you might think he managed to pull off some pretty clever maneuvering in the face of a ruthless Tea Party-led Congress. They started out talking about $4 trillion cut, they're down to $2.1. Is that a good, or even credible result? No. It's just playing around with numbers: these guys have simply agreed to keep raising the debt ceiling in the same proportion as the deficit is cut. But the main advances the Democrats stood for and Obama tried to enact have all - yes, everyone one of them - been rejected. Politically, this is a great victory for the Republicans and a great defeat for the Democrats. Worse, the President is the one who surrendered. He pushed himself forward in the negotiations, but he didn't come home with anything worthwhile for the middle class he says he wants to defend.

He now says he's going to campaign on raising taxes on the wealthy - that might win back some of the Democrats, but not all.

Because he has let his electorate down and many Democrats are not only disappointed, they are actually furious with him. This does not bode well for his re-election...

Of course, the elections are still far off - over a year's time - and the economic situation could improve, you never know. As is well known, any incumbent president needs good economic numbers to win re-election. That was the case with Bill Clinton who also faced a Republican Congress and had to give in on many political issues at the time. But the economy was picking up and he was re-elected. Can Obama hope for the same? Not likely. It would require a real change - for example a strong government support for clean energies, an effort to help and retrain the unemployed for new jobs, a real change in the fiscal injustices that allow American corporations to avoid paying taxes in the measure of...$1 trillion per year (yes, that's not a typo!). In the present political context, there is clearly not the slightest chance that this will come to pass. What with Republicans bent on cutting back the role of government to its absolute minimum and a President who is afraid to stand up to their demands, the outlook is dire. Perhaps Obama is not actually afraid, but unquestionably he lacks negotiating experience: he hasn't been long enough around Washington and still believes in what people tell him. It's refreshing, to be sure, but unquestionably naive.

Finally, just to make matters worse, it is very likely that one, if not all three, of the rating agencies will downgrade the US debt byt a notch or two. If not right away, in a few months' time when it becomes evident to all that Washington is playing a political game with the debt that has nothing to do with responsible economic governance.

Tentative conclusion: A downgrading of the US debt in the near future. And that is sure to send the world in a tailspin.

Because, up to now, the international trade system was based on the American dollar. The US treasury bonds were the ultimate safe investment.

The ultimate irony is - would you ever believe it? - that in spite of all the American debt deal mess, the American dollar and US Treasure bills will continue to play their fundamental role in the global financial play between nations.

And do you know why? Because of the situation in Europe. With the festering two-year old Euro crisis that is now threatening to extend from Greece, Ireland and Portugal to Spain and Italy, there is still no currency that can rival the dollar. Certainly not Japan still struggling to recover from the Tsunami. And not Switzerland - the safe haven par excellence - but too small to play a global role (an as I am writing, the Swiss Central Bank is now working to curb the Swiss Franc's rise). The Chinese renmimbi? Don't count on it. The Chinese have internal political problems of their own, plus a steady rise in production costs not to mention dangerous imbalances caused by a mad real estate bubble.

In short, we are in the hands of incredibly incapable politicians all around, on both sides of the Atlantic, and it's not likely to get better any time soon!

What's your take on this?Do you think we'll escape a double dip recession and continue with a Strong Dollar underpinning the World Economy? Or are we headed downhill?

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