The US debt deal and the recovery

US dollar bills Image copyright Reuters
Image caption 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.