Dangerous Agreement

The agreement to raise the debt ceiling avoids a default but threatens recovery.

The eleventh-hour agreement between Democrats and Republicans in the United States to raise the debt ceiling — pending approval by the two chambers of Congress this morning — saves the normal functioning of the U.S. economic system until 2013, the remainder of Barack Obama’s term. But it also sends the message that the radical core of the Republican Party, the tea party, will be an obstacle to crisis management in Washington. The agreement saves the present because it avoids a default, but it threatens the future.

Obama lost to the Republicans. He admitted it himself when he said: “Is this the deal I would have preferred? No.” The debt ceiling has been raised by nearly $2 trillion, but one condition made by Republicans is that deficit reduction must amount to more than the margin of debt. In addition, the Republicans (or, more precisely, the tea party, which was the party’s most active element during these negotiations) rejected the proposal that deficit reduction would include a tax increase for those with high incomes. The agreement assures that there will be no default until 2013, but it compromises the economic policies of the president.

The reason is that the conditions imposed by Republicans seriously weaken the government’s ability to start a strong and sustained recovery. Fiscal restrictions will prevent recovery and slow down both growth (predictions for 2011 are just 2.5 percent) and employment (it’s unlikely that the unemployment rate will drop from 9 percent). If Ben Bernanke’s quantitative easing has already been questioned by the International Monetary Fund, then the Caudine Forks through which Barack Obama has been seen passing under the triumphant watch of the Republicans will end up ruining the effectiveness of the fiscal policy.

The markets perceived this contradiction. If at the beginning of the day they reacted with a certain euphoria to the announcement of the agreement, later their enthusiasm cooled as they warned that the U.S. economy would not respond and that the drastic budgetary cuts involved in the debt deal will burden growth (and, consequently, the ability to pay off the debt). In the weakest parts of the financial system the losses were significant. In Spain, the market fell 3.24 percent and the risk premium reached 370 basis points.

Right now the United States finds itself in the same trap as the Old World. As is the case in many European countries, in order to avoid a default it is necessary to enact fiscal readjustments (in this case the product of an internal political agreement), which have the consequence of limiting growth. The United States is obviously not Europe. Its domestic and international financial structures allow it greater leeway. But the agreement jeopardizes U.S. growth and employment. The fear that the ratings agencies may downgrade U.S. debt is then not unfounded.