Etar Ltd

April 25, 2011 18:11 ET

Clinging to the Ceiling-the Uncertainty of Short and Long-Term Tradeoffs Between Debt and Tax Cuts

NEW YORK, NEW YORK--(Marketwire - April 25, 2011) - Even though US Congress has until the recess to vote on a debt ceiling, the range of possibilities is narrowing down by the day, as markets lose patience and start building up their own scenarios. In recent weeks Congress managed, after heated debates, to pass a federal budget just in time to avoid a government shutdown. Now, Congress and the White House both confront a challenge of avoiding a blackout of the national economy as the existing $14.3 trillion cap on borrowing is expected to be reached by May 16. To avoid default on its debt, Congress would need to institute a higher debt ceiling. But to do so without cuts in public spending would kill the entire purpose of reducing public debt and the budget deficit.

US public debt has already mushroomed to more than 60% of the country's GDP following the global financial crisis. It is estimated the government needs at least $1 trillion to continue its operations through the fiscal year ending September 30. The already charged atmosphere on the Capitol Hill is exacerbated by the expectation that the US government is to face a record $1.5 trillion budget deficit in 2011.

Ultimately, whatever the Government does is usually factored-in by the markets, sometimes before the government decision is announced and even made, in line with Jacques Derrida's view that "the circle of debt, of exchange, or of symbolic equilibrium reconstitutes itself according to the laws of the unconscious." The recent downgrade by Standard & Poor's of its long-term outlook for the US fiscal position from "stable" to "negative" for the first time shows a cautionary trend. If no deal is reached to rein in the swelling public debt and budget deficit, there is a likelihood of a snowball effect. A possible stalemate on the Hill and further downgrades could result in tighter credit market and increased borrowing costs. Dumping of US Treasury bonds could spur outflow of capital, weakening the dollar and leading to higher oil prices, among others. This would seriously undermine both national and global economic growth and recovery.

This makes a bi-partisan compromise on the debt ceiling a no-brainer, at first glance. The issue is, at what terms. For Congress to pass a debt-ceiling legislation soon would entail satisfying sensible demands for spending cuts as a guarantee for deficit reduction. Because this will also be factored-in by the markets, the lesser the guarantees, the more volatility would the US be facing when financing government debt in the future. And as to economic growth, the recovery is still sufficiently fragile for it to be subjected to unnecessary turbulences, which would be inevitable if the US is suddenly faced with a mounting wave of debt.

The urgency and scale of the impending economic storm therefore provide only one viable option: agreeing to increase the debt ceiling should go together with spending cuts. These cuts, however, would have to be substantial if the government is serious about pursuing a fiscally responsible economic policy and putting its financial house in order. To restore market confidence and put the US economy back on competitive tracks, the Obama administration should thus work with both parties to cut massive government spending. Such a measure is essential because a higher debt ceiling, although providing some short term relief, exacerbates rather than resolves the national debt problem in the long run.

Georgette Mosbacher, CEO, Borghese, Inc., Member of the Board, Goodwill Ambassador and Chairman, Public Diplomacy Council, Royal United Services for Defence and Security Studies (RUSI) Int'l

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