Debt Ceiling Deal: All cuts, no taxes

Below is a video with UMass Professor Thomas Ferguson discussing the politics and economics of the debt ceiling deal that recently passed the House and the Senate. Tom’s view is that this is basically a ‘Republican’ deal i.e. all spending cuts and no tax increases. Tom says that the spending cuts would not include defense in the first round and so would be borne disproportionately by ordinary citizens via social programs like student loans.

My take has more to do with the politics than the economics of the matter. I was on the BBC earlier today to talk about the debt crisis after the Senate approved the legislation raising the debt ceiling. Just as I was saying that this was a manufactured crisis, we cut away to President Obama who made many of the points I had intended to make, even using my phraseology ‘manufactured crisis’.

Before I get into the politics, let me quote this regarding real and manufactured crises from a previous post at Credit Writedowns first since I will be talking about the European debt crisis tonight on the CBC.

In countries that issue debt in their own currency, the crisis will be ‘fake’, meaning that the overwhelming majority of questions from those who don’t understand how money works will revolve around solvency. Government creates the currency, they can always manufacture more to fulfil IOUs in that currency if they so choose. The real question should go to malinvestment, currency depreciation and inflation.

In countries that do not issue debt in their own currency, this crisis will be real. As we have seen with the euro zone, being a currency user means involuntary default is a real medium-term issue.

P.S. – I am not concerned about an involuntary default by the US government for solvency reasons. I am concerned about a voluntary default by the US government for political reasons.

–What is deleveraging?, April 2011

In the U.S., the problem is political. The crisis has been manufactured to prevent more deficit spending. There are no solvency constraints. Understanding the sovereign debt crisis and currency sovereignty makes that plain. The crisis in Europe is about politics too, but it is also liquidity and solvency. Greece doesn’t create the euro. Spain doesn’t create the euro. Ireland doesn’t create the euro. They need to ‘get’ euros and that makes them all vulnerable.

As for the politics, the President basically talked about this economic malaise as being more about jobs and less about government spending. He added that the second round of negotiations over cuts have to ask corporations and wealthy Americans to do some of the heavy lifting since most of it is being done by the middle classes in the US.

Politically, that all plays well. These are good sound bites and it is exactly what Americans in the middle of the electorate want to hear. Given these themes play right into what I see as Obama’s economic agenda for re-election, it is clear the President has an eye to re-election in everything he says. Following through on the rhetoric is another question altogether.

When I reviewed the President’s budget proposal in February, I thought then that it was geared to re-election, but it was “more geared to the Democratic base than I was saying it would be in October and November”. I meant the President didn’t act on the Simpson-Bowles deficit commission recommendations, knowing that a fight with the Republicans in Congress would push him toward a Simpson-Bowles outcome. The President could claim that he wanted to keep Americans from more economic pain but that the Republicans had taken the economy hostage.

I said then:

The attacks from both sides make Obama look like a centrist – exactly what he is looking for. Right now, as far as the Clintonistas in the White House are concerned, 2010 was a replay of 1994. And that mandates the same tack to the center in order to win re-election. My view is that this could work for Obama if the economy holds. At this point in the economic cycle, I believe 2012 is going to be more of a referendum on the economy than specific policy prescriptions.

Unfortunately for President Obama, the economy is not doing well. And the cuts envisaged in this deal make that problem worse. From an electoral standpoint this is already becoming a problem in key swing states like Pennsylvania.

I believe Obama is a triangulating New Democrat. His kneejerk reaction, therefore, is to look back to 1994 and draw the same conclusions Bill Clinton did. So, while this deal makes political sense if you look at it from a election of 1996 context, it doesn’t make sense if you look at the economy from a 1937 or 1938 context. And ultimately that is the problem we will all face in 2012.

Also see: What the debt-ceiling battle means for 2012 from the Washington Post