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After Budget Battle, Hope on Debt War

Author: Sebastian Mallaby, Paul A. Volcker Senior Fellow for International Economics and Director of the Maurice R. Greenberg Center for Geoeconomic Studies
April 11, 2011

After Budget Battle, Hope on Debt War - after-budget-battle-hope-on-debt-war

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Last week's budget battle in Washington, which narrowly avoided triggering a government shutdown, may prove to be a turning point for the U.S. fiscal outlook, and by extension for U.S. power. Until recently, there had been little sign that President Barack Obama or the divided Congress would face up to the nation's looming debt crisis. The Obama administration had set up a budget commission and then ignored its recommendations; Republicans in Congress had called for cuts in discretionary spending while sidestepping the far more important challenges of tax and entitlement reform.  But there now seems to be at least a modest chance that real reform is possible. The odds may have improved as much as tenfold--from 1 to 10 percent.

This small measure of encouragement has little to do with the $38 billion worth of cuts to the current year's budget announced on Friday evening, even though Obama called these "the biggest annual spending cuts in history." With the U.S. federal debt at $14.2 trillion, $38 billion is not enough to make much of a difference to the U.S. reliance on its creditors--including, notably, foreign governments. Rather, the good news lies in the lessons to be drawn from last week's politicking, and the momentum that it may create.

The outcome was a triumph for House Republican Speaker John Boehner, who has shown he can translate the deficit-cutting passion of the Tea Party freshmen into solid legislative results. Boehner succeeded in forcing Democrats to concede far more cuts than they had wanted, but he avoided being so intransigent as to trigger an Obama veto. As a byproduct of the negotiating process, Obama and Boehner spent more time with each other in one week than they had done since the latter ascended to House speaker. They have forged a productive working relationship that may prove invaluable during the far more significant debates ahead.

These debates will be kept on the front burner by the need to raise the U.S. federal debt ceiling before Washington bumps up against it next month. Republican deficit hawks vow not to vote for extra borrowing--a largely non-credible threat, since a failure to raise the ceiling would trigger a catastrophic meltdown for which the hawks would be blamed. Still, Boehner may be able to use Tea Party intransigence to force the administration to the negotiating table on entitlement reform or tax reform. Last week, Representative Paul Ryan, the deficit hawks' champion, unveiled an entitlement reform package that included blood-curdling cuts in government health programs. There is no way the Democrats will accept this path to fiscal sanity, but Ryan's proposal may force the president and his congressional allies to lay out an alternative way.

It is hard to overstate the stakes here. The United States is headed for fiscal disaster, with dire consequences both for American living standards and for the U.S. ability to project power. Either political leaders will muster the courage to make hard budget adjustments. Or the bond markets, including substantial foreign investors, will at some point lose their appetite for funding endless deficits, at which point interest rates will rise, the dollar will fall, and the United States will experience an adjustment of a far more painful sort.

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