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Debt Crisis Prompts Global Angst

Author: Jonathan Masters, Deputy Editor
August 2, 2011

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After months of impasse, an agreement that raises the U.S. debt limit (BBC) ahead of default was signed into law on Tuesday afternoon. But critics at home and abroad are expressing annoyance at what they see as a U.S. political system incapable of overcoming partisan rancor in conducting essential national business. The Budget Control Act of 2011 (WSJ) allows up to a $2.4 trillion rise in the debt ceiling (in three tranches), immediately institutes ten-year discretionary spending caps totaling nearly $1 trillion, and creates a bipartisan committee charged with identifying mandatory deficit reductions of at least an additional $1.5 trillion by Thanksgiving.

Expectations of a long-awaited U.S. debt deal drove "relief rallies" in foreign markets, including gains in the major European and Asian indices, but economists suggest the increases may only be temporary given that the expected agreement does not dispel fundamental investor concerns over a weak U.S. economy (FT). While U.S. markets initially surged on the news from Washington, reports of dismal growth in domestic manufacturing helped precipitate a commensurate sell-off and fed fears of a wider economic slowdown. Questions also remain as to a whether the country will receive a downgrade in its top credit rating (NPR).

Some major U.S. debtholders in the international community expressed displeasure about how the United States has managed the debt-ceiling crisis. Speaking at a political rally, Russian Prime Minister Vladimir Putin (WSJ) maligned the United States as "a parasite" due to its mammoth debt obligations, and encouraged Russia and other nations to seek a new reserve currency. A recent editorial in Xinhua, a state-run Chinese media outlet, called the debt-ceiling showdown "dangerously irresponsible" and urged the United States to "to conduct an in-depth self-examination."

Morgan Stanley's Stephen Roach, writing on the reaction in Asia (ProjectSyndicate), says the recent fiscal brinkmanship has driven a loss of confidence in the U.S. government and its global economic leadership. In the wake of the U.S. subprime crisis, which sparked a global financial meltdown, Roach says the debt-ceiling debacle "is the last straw" for Chinese officials, who are "appalled at how the United States allows politics to trump financial stability." Beijing is particularly vulnerable to any uncertainty in the U.S. debt market, with some 60 percent of its $3.2 trillion in forex reserves parked in dollar-denominated assets. Writing for the Diplomat, Minxin Pei says this "$2 trillion hole" may force "a more rapid pace of revaluation of the renminbi," as China seeks to reduce its vast current account surplus.

International investors have yet to jump ship from the U.S. Treasury market, despite their obvious qualms. In fact, bond prices (CNN) increased throughout the debt crisis, including last Friday, though after Congress reached a deal on Monday, prices actually fell. Analysts claim this seeming paradox indicates that investors are less worried about excessive U.S. debt than fundamental economic conditions (U.S. manufacturing) and a steady supply of treasuries.

The budget compromise assures that fiscal policy, at least in the short term, will not be used to stimulate a sputtering U.S. economy, even though many economists have called for greater federal spending to sustain a recovery. The deal also ensures that much political theater lies ahead, as policymakers try to flesh out the details of proposed cuts. Writing for TIME, Michael Schuman suggests this translates into prolonged uncertainty in global financial markets. "If I were a policymaker in Tokyo or Beijing or New Delhi, I'd want to make myself less dependent on a country where the political process appears unreliable and heightens the risk to the global economy."

Selected Analysis:

While the United States may avoid a crippling default, the country still faces a "democracy crisis," and needs reforms to allow Congress to act effectively, write Jacob S. Hacker and Oona A. Hathaway in the New York Times. Reforms are needed that allow Congress to act effectively.

The best way to bring the U.S. debt-to-GDP ratio under control is to limit future spending increases, particularly in healthcare, and boost revenue while the economy continues to recover, testifies the Peterson Institute's Simon Johnson before the House Ways and Means Committee.

The United States can solve its debt crisis, but sustainable prosperity lies in improved productivity and real wage growth, not asset bubbles, writes Larry Elliott for the Guardian.

The brush with a U.S. default and lingering fiscal woes increase the appeal of a balanced budget amendment, writes Edward Glaeser for Bloomberg.

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