Why the Compromise Hurts the U.S. Economy

Bankruptcy has been averted, but in spite of that, the compromise announced by President Obama is economically inadequate. It does not solve any of the budget problems and it even damages certain budget elements. It is by no means certain that the U.S. will be able to maintain its AAA rating. Only a change in the way America does business can actually defuse the situation.

The United States won’t declare bankruptcy and will continue to pay its bills as promptly as it ever has; nor will the U.S. be forced to withhold monthly checks to military veterans and the needy.

Literally at the last minute, the U.S. Senate came up with a compromise that raised the debt ceiling and called for massive budget reductions, sparing President Obama a second big budget debate in the middle of his election campaign. Early Monday evening it looked as though militant conservatives in the House of Representatives would sign on to the compromise, but no one was entirely certain; tea party movement activists can always be counted on for surprises.

Assuming that political sanity wins out and the Senate compromise becomes law, the United States has dodged the bullet. But — and this is the major limitation — none of America’s budgetary problems will be solved. There’s absolutely no guarantee that the United States will be able to permanently hang on to its AAA credit rating; the future of the endangered Medicare program is also an utter unknown. And almost everyone outside the Republican Party knows that the budget can only be refurbished with a combination of spending cuts and revenue increases.

The tax rate — that is, the ratio of taxes to overall GDP — is lower now than it was in the early 1960s. But tax increases are taboo for the Republican base and it now has so much leverage that Democrats have simply surrendered on that issue.

Several elements of the compromise will damage the U.S. economy. Cutbacks are to begin immediately, at a time when the economy is so weak that sliding back into a recession is a strong possibility. The classic economic solution to such a situation would be to prepare long-range spending cutbacks, but to not implement them immediately. However, that mainstream economic theory doesn’t stand a chance in Washington these days. Government has to shrink, regardless of the ramifications.

The president wanted to reach a grand bargain, a great compromise, and gave in to many Republican demands. It didn’t pay off for him. The president suffered almost greater damage in the fight to raise the debt ceiling than did Congress.

What America really needs is this: a grand bargain, a consensus on just how much the American people are willing to give the government in taxes and how that burden is to be shared. And it is also necessary to reach a consensus as to how much Americans are willing to pay to keep their military superpower status and which military responsibilities they’re willing to take on for themselves and their allies.

That consensus will be reached someday because the flexibility of America’s political system has always ensured it. But it’s highly possible that the compromise will only survive if the global economy becomes worse than it is at present. No one can forget the bloodletting that took place throughout the whole debt debate. That weighs heavily on America’s international reputation. As financial markets see it, Washington’s dysfunctional attitude is a risk factor that has to be considered in the future.

But America isn’t Greece and any comparisons in that vein can’t be taken seriously. U.S. debt is currently near 100 percent of GDP, not 150 percent. Capital markets are profitable and, above all, behind everything stands a powerful and productive economy. Despite that, the U.S. and European debt crises are relevant to each other. Never before in history have debt levels in the industrialized world been so high during peacetime. That indicates a massive weakness in the part of the world still referred to as “the West.”

Those nations that, until recently, decided the fate of the rest of the world now find themselves on a fiscal path that isn’t sustainable. The grotesque display in Washington over the past few weeks clearly illustrated that.

But the fact that Europe’s debt crisis is obviously not yet settled either also has a global cost. “The lucky thing for us is that we are in a race with Europe and Japan for most financially irresponsible superpower,” Walter Russell Mead, a professor at Bard College and author of many works on the waxing and waning of American power, said on Sunday. “And right now the Europeans and Japanese have substantial advantages in that race.”

Over the past few days, one might argue whether those advantages still exist. That would be little consolation for Europe. Government debt is an epochal problem of global dimension, and at best the solutions have only just begun.