Uneasy peace over trillion dollar debt pile

When it comes to US government debt deals, the battle is, in the words of legendary New York Yankees baseball coach Yogi Berra, “Ain’t over til it’s over.”

Financial markets can breathe a sigh of relief that a bitterly divided House of Representatives has managed to cut the Biden government’s spending commitments by $1.32 trillion (£1.1 trillion) and avoid a default.

US Treasury Secretary Janet Yellen warned that if a deal was not struck by June 5 (Monday), the almighty US government would hit the $31 trillion (£25 trillion) legal ceiling on national debt. He would no longer be able to pay the enormous interest and would default.

That, it was feared, would make the US a pariah in the markets – alongside outliers like Argentina and Sri Lanka – leading to a disastrous drop in credit ratings.

Undermining confidence in US government bonds or bonds – held in the reserves of countries around the world – could unleash a tsunami as damaging as the financial crisis of 2007-2009.

Such a catastrophe has been averted, and anyone who has followed America’s heated debates over deficits and debt over the past few decades knows that strong elements of political tour de force were involved, with a presidential election looming in 2024.

It is no coincidence that the deal that the House finalized with President Biden’s approval on Thursday is set to expire after the election — a problem for the next White House occupant.

And it could be overturned in the Senate. All it takes is one renegade senator filibustering on weekends and holding things up to provoke another crisis.

America’s debt problem didn’t just happen. The debt-to-national output ratio of 123.4 percent of GDP is a legacy of former President Trump’s Covid spending and Joe Biden’s fiscal generosity.

Under Biden, the US budget deficit has increased by $4.8 trillion (£3.9 trillion) or, to put it another way, two years of Britain’s total output. Labor shadow chancellor Rachel Reeves avoided discussing arithmetic in her Washington speech on May 24, praising the Biden administration for “rebuilding economic security, strength and resilience.”

One can understand why Labor is eager to join a Biden administration for the second term. Instead, she criticized Chancellor Jeremy Hunt for accusing Americans of being involved in a “distortive global subsidy race.” That is exactly what the US Chips and Science Act and the falsely named Inflation Reduction Act are for.

Hardly a day goes by without British companies, such as Scottish battery maker AMTE or energy company Drax, saying they intend to move some production to the US.

Biden’s intentions may be noble, making progress on green energy and reducing dependence on China for semiconductors, but the impact is that of a giant magnet that attracts investment.

Britain can stretch its balance sheet with grants, loan guarantees and other measures to attract green investment. But fragile government finances, pushing government bond yields (gold-rimmed stocks) back into the danger zone, prevent the Rishi Sunak government or any future Labor government from effectively competing with the US. Usually, world markets can ignore America’s fiscal generosity because the dollar enjoys the privilege of being the world’s reserve currency.

That allows it to print or issue more US Treasuries because there is always a country with a large surplus (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 reverse Biden’s big spending. House Republicans, led by Speaker Kevin McCarthy, had a target of up to $4.63 trillion (£3.7 trillion).

In the midst of the grudges, there were small victories. Funding for the Internal Revenue Service over the next decade has been cut by $21.4 billion (£17.3 billion) from $80 billion (£64.5 billion). Republicans feared an intrusive army of tens of thousands of new tax officials who would delve into every aspect of people’s lives. In reality, the complaints were less about the 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 deal with evasion and evasion.

Most of the time, the cuts or savings will come from discretionary spending – the military budget, war veterans’ health funds, and Social Security (pensions) are fully protected.

Attempts to nullify plans to cancel $460bn (£371bn) in student loans failed. The deal looks like a no-score political tie, though Biden and the Democrats may have won on penalties. It contains the debt panic, but does little to end the deficit and mountain of debt. The longer-term concern is that it will be much more difficult to reduce inflation and that this could lead to higher interest rates for longer.

Higher borrowing costs could dampen growth in the world’s most resilient advanced economy.

That cannot be good for prosperity around the world.