When U.S. President Barack Obama announced Sunday night that he and Congressional leaders had finally reached an agreement to raise the government debt ceiling, the world breathed a collective sigh of relief. Stock markets in Asia jumped on the news. Yes, the pact still has to pass through the Senate and unruly House of Representatives (a vote will take place today) before becoming official. But in all likelihood the scary game of brinksmanship between the country’s two political parties has come to an end (for now), and as a result, the U.S. will likely not default on Tuesday. If the world’s most important economy had actually been unable to pay its bills, the consequences for the global economy could have been biblical. The fact that we (barely) averted such a disaster is a bit of good news, something investors haven’t had much of recently.
But just as a default by the U.S. would have had an outsized impact on the global economy, due to the unique position of America in the world, a deal struck to alter the direction of fiscal policy will also have a tremendous effect. The decisions made (or in this case, not made) by Washington in the debt agreement will reverberate through the world economy for years to come.
First of all, in the short term, we can all forget about U.S. fiscal policy being employed to stimulate the anemic recovery in the world’s largest economy. The debt deal, by capping annual appropriations and imposing $2.4 trillion in spending cuts over the next decade, takes any hope of further stimulus off the table. We can debate whether or not that’s a good idea, With U.S. GDP growth at an annualized rate of a mere 1.3% in the second quarter, and unemployment still astronomical at 9.2%, some economists have been arguing the U.S. needs more spending, not cutting, to keep the recovery alive. But Washington has chosen fiscal repair over economic repair. That means a lot to Americans – especially those millions still looking for work – but it also means a lot to the rest of the world. Companies and workers from southern China to southern Africa depend on the giant U.S. economy, so a slow recovery in the U.S. eats into growth prospects everywhere else, even roaring emerging markets like China. (The HSBC purchasing managers’ index for China fell below 50 for the first time in a year in July, a sign that its manufacturing sector is slowing.)
Secondly, the debt deal hasn’t fully determined the future course of U.S. fiscal policy, and that sad fact means haggling in Washington will continue to plague world markets. Though the parties agreed on the big-picture direction of future spending and cuts, it left nearly all of the details to be determined at a later point, mainly by Congressional committees. We have no clear idea which programs will get the axe, and by how much, nor what role taxes increases or reforms will play into the mix. So the battle between left and right over how to close the budget deficit is, in some ways, just getting underway, and is likely to continue over the coming months and even years. That means continued uncertainty in global financial markets for a long time to come.
Third, budget cuts will have a ripple effect through the entire world, and the world is going to have to adjust to what gets cut. For example, the pact mandates hundreds of billions of dollars of defense cuts over the next 10 years. As I recently noted, such cutting could have a profound effect on the state of global security. The U.S. military presence around the world has provided a certain level of stability in global affairs, and no other nation (or organization) has the capability of taking over this unique American role. Some countries, such as Japan, depend on the U.S. for their own security. So if the U.S. can no longer afford such international commitments, the entire way the world handles security problems (terrorism, for example) will be forced to change. Everyone from the Saudi royal family to Taliban commanders will be watching closely to see how the U.S. restructures its military spending, to look for new weakness, and new opportunities. Who knows where this process will lead.
Fourth, the debt deal – or, more specifically, the ugly process of getting the deal done – could well hasten the decline of American influence in the global economy. The irresponsible brinksmanship and childish squabbling made American political leaders look more like The Real Housewives of New Jersey than the leaders of the free world. 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 risks to the global economy. That gives countries like China, for example, even more incentive to diversify away from holding U.S. assets, undermining American dominance of the global financial system. At a time when the world economy requires strong U.S. leadership, the world is getting just the opposite. That’s not positive for America’s future standing in the world.
However, there might just be a glimmer of something positive here. If Washington can actually devise and stick to a real plan to shore up the country’s finances, the position of the U.S. in the global economy could actually strengthen. Look at how the dollar rallied just on the news of the deal. Imagine what could happen if the deal led to true reform. A credible fiscal repair plan could build confidence in the U.S. economy, the U.S. dollar and most of all, U.S. stewardship of the world economy. So there is a chance that we could be witnessing the start of a revival of American influence in the world economy. If…well, there a lot of ifs to get through before that can happen.