The US debt deal and the recovery

US dollar bills There are plenty of big scary numbers in the debt deal

It's peace in our time on Capitol Hill, but the risk of a formal US default was always tiny. Two more important worries hanging over the markets have been that the US will lose its AAA rating and that America's recovery might be grinding to a halt.

Recent events have done little to appease those concerns. Indeed, in the case of the economy, the outlook looks considerably worse.

There's no word, yet, from the major ratings agencies, whether Washington has done enough to hold on to America's top credit rating. Reasonably enough, they are probably waiting to see the details. But if Standard & Poor's stands by its previous warnings on US debt, you have to say that a downgrade is now more likely than not - though it might wait to see the budget negotiations later in the year before pulling the trigger.

S & P had previously suggested they were looking for a "credible plan" involving spending cuts or tax rises in the region of $4 trillion over 10 years. According to the Congressional Budget Office, the deal passed by Congress will lower the deficit by $2.1tn, but in several stages, and with only the first $917bn even vaguely spelled out.

Most of the ratings agencies wanted to see tax rises as a part of any plan, and - above all - a commitment to stabilising the debt as a share of GDP. The deal hammered out at the weekend doesn't seem to guarantee either. In fact, in the case of tax rises, they are largely ruled out, to the great frustration of many Democrats.

So, we could still be looking at the US losing its triple-A credit rating. Does this mean the end of the world?

As I discussed last week, a downgrade could cause trouble in the markets - or it could simply force everyone to adjust their conception of safe government debt. Usually, the world adjusts itself to the US, rather than the other way round.

Reasonable people can disagree on which is more likely. But for the moment, the financial markets seem to be more worried about the state of the US economy than its creditworthiness: the yield on US 10-year debt is today hovering around 2.9%, nearly 0.8 percentage points lower than it was six months ago.

We also found out today that Pimco, the world's largest bond fund, has been buying US treasury bonds again. Not so long ago, its manager, Bill Gross, was telling everyone who would listen that US yields were about to soar.

With all the bad economic news coming out of the US in the past few days, should we be worried that an outbreak of fiscal austerity is about to make things even worse? The answer is it all depends what happens next.

This weekend's deal, on its own, is actually fairly backloaded when it comes to direct spending cuts. Of the $917bn in specified cuts over 10 years, the CBO reckons that only around $20bn will come in next year.

But the "baseline" for all the deficit forecasts assumes that neither President Obama's temporary payroll tax cut, nor the emergency extension of unemployment benefits will be extended into 2012. Between them, those are worth about $150bn and will have a much larger impact on the economy in 2012 than the cuts agreed this weekend.

If those stimulus measures are not extended, the US will be cutting borrowing by around 3% of GDP in 2012 - compared with tightening of 1.7 percentage points in the UK. That sounds like a lot, if the recovery continues to stumble.

That is why most people in Washington - including the IMF - believe those temporary measures will be extended. And it is why the president's office has confirmed that he will continue to fight for that money to be spent, even as he prepares to sign a budget deal which assumes it will not.

American politics, and its sovereign credit rating, are likely to be greatly affected by the events of the past few weeks. But the short-term impact on the US and global economy is still very much up for grabs.

Stephanie Flanders Article written by Stephanie Flanders Stephanie Flanders Former economics editor

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  • rate this

    Comment number 295.

    288 Tim0thy
    Thanks for the link. There was indeed some laundering, and a lot of sloppy controls. The whole $279bn as drugs money seems unlikely or the penalty would have been much higher. A DC-9 even in 2006 would not have cost an enormous amount.
    The Guardian as a conspiracy theory? – well borderline.

  • rate this

    Comment number 294.

    Simple ...Introduce NESARA !

  • rate this

    Comment number 293.

    Stander bank has a big stake in US bonds. Global banks and financial markets have made some unwelcome links ...this global village feels good when things go right but it pinches when things go wrong and things can impact you or I over which we have No control and no way of predicting, and you as a consumer or citizen haves to pay more from your pay for mistakes made by governments of other ctrs

  • rate this

    Comment number 292.

    This debt is unbelievable...who let the the US govt borrow so much money???if the rating agency downgrades US bonds, than any mutual fund, or global bank with a large investment in US treasury bills or bonds will face similar downgrades. This will increase their cost of capital which will be passed onto their customers in their home countries. So a mortgage rate may go up in Spain because

  • rate this

    Comment number 291.

    260.Chris London
    9 Hours ago
    Strange, China has resource issues and their costs.
    Well you're good at stating the obvious!

    What you may not understand is that while China has problems like all BRIC countries - much of their success is our loss - they're feeding on us

    We're in a trade war - and we're losing heavily & things will get worse for the UK with 'zero strategy'

  • rate this

    Comment number 290.

    261.Chris London
    Brazil - left itself exposed.
    That is complete & tosh!

    Brasil has problems & is going through a transition phase in getting a grasp of their changes/growth - but is in much better position than the UK.
    I expect Brasil to become global No 1 economy during next twenty years & all it has to do, is to learn how to best deal with those greedy foreigners.

  • rate this

    Comment number 289.

    262.Chris London
    258.nautonier - India
    Yes - and my point is that taking India as a BRIC example - their position would be much, much worse if they adopted our ridiculous UK totally open global economic capital market 'political play-thing policies' - their command macro economy is still better managed than ours, in economic terms, bearing in mind what India has and hasn't got & origin

  • rate this

    Comment number 288.

    287. AnotherEngineer
    I hope the Guardian doesn't come on your list of conspiracy theorists.

    Interesting thing to me is how they were caught and fined but only fined $150 million for laundering $374billion. Nice business even at .005% commission.

  • rate this

    Comment number 287.

    It is only 3 or 4 years ago when a US bank was found to have laundered 374bn US$ in drug money!


    Have you got any more details (not a conspiracy theory web site)please?

  • rate this

    Comment number 286.

    IMHO we have created a monster, the internet and global telecoms, computerised trading, massively unregulated world wide banks. National politicians are powerless to stop this. It will take concerted international action and the present bunch of world leaders do not have what it takes. It is only 3 or 4 years ago when a US bank was found to have laundered 374bn US$ in drug money!

  • rate this

    Comment number 285.

    Chris London
    A non economist view of the Portuguese bail out.

    If one thing is now obvious it is that unregulated free market capitalism and monetarist orthodoxy are as exploded as are the doctrines of state socialism and communism. We need to get control of the world free market slush funds and quickly.

  • rate this

    Comment number 284.

    I must be missing the point surely what the americans have just voted for was exactly the reason for the big upset three years ago with the banks/building society lending money to borrowers who couldnt pay it back.

  • rate this

    Comment number 283.

    Chris London 'versus' the others!
    Right or Wrong?
    Need to Transcend!

    Good to share facts, trends, strategic perspectives, disagreements

    Must rise above noise, sterile repetition in news & analysis

    Must live 'in the minute'...

    MIGHT live millennia with DEMOCRATIC self-control through FREEDOM OF CONSCIENCE with INCOME EQUALITY

    Never too late?
    We play Chicken, at the expense of poor and future

  • rate this

    Comment number 282.

    CL 255.

    More than likely,in fact probable.

    The corruption is the shorter term issue,.In the longer term the political influence of the press is at stake.

    Those who criticize the BBC for its left liberal bias coneniently forget the Tories have the press,most of it for most of the time.

  • rate this

    Comment number 281.

    272. Chris London
    "There are two issues with the EU and Euro besides the obvious which are contributing to its downfall."

    I'm only a bear of very little brain, pray tell me what is the obvious? Is it, perhaps, that you don't like it?

  • rate this

    Comment number 280.

    276. Chris London
    As for France what is really needs is a politician that doesn't think that waving his arms about and organising endless conferences is achieving something. It is unfortunately true of most of the world at this moment we seem to be led by a bunch of second raters. Look at the UK the PM is an ex PR spin doctor and the chancellor of the exchequer has a 2nd class honours in history

  • rate this

    Comment number 279.

    270. Chris London
    The answer was just about as expected. Switzerland, I'm surprised that you didn't bring up Norway as well. Switzerland with a population of less than 8 million and although not part if the EU highly integrated into it. The UK with it's population of 63 million would, I suggest, need a little more volume to survive than it could gain by emulating Switzerland. Contd.

  • rate this

    Comment number 278.

    271. Chris London
    The trouble with eminent economists is, as has been said many times before, that you put 20 of them in a room and you will have 20 opinions. I live in the real world and I am looking at the downside of a crash of the EU Euro $US and wondering how, if economists are so clever, did we get into this mess? Perhaps when giving an alternative UK vision you could explain this as well

  • rate this

    Comment number 277.

    I see the BoE MC have bottled it once again and held interest rates on hold. Now lets see inflation go pop. My basket (an experiment on the true cost of living) has risen again this month by more than 2%. Thats an overall jump of over 8% since I started this experiment and Makes a mockery of the numbers published. Food and Fuel are rising well above the declared inflation rate.

  • rate this

    Comment number 276.

    From the FT
    "France, like other European states, needs to demonstrate more fiscal responsibility than it did in the euro’s first 10 years. But constitutional amendments that serve as fiscal straitjackets are not the answer. What France needs most of all are political leaders with the courage to tell voters that the nation must live within its means. "

    I couldn't agree more for all the EU.


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