Photo: Reuters

As you have come to know by now that the United States Congress voted to raise the federal debt limit just hours before the deadline was to expire on Aug 2. Failure to do so would have led to the US treasury running short of cash to pay the nation’s bills.

The vote followed a last-minute agreement reached between the Congressional Republican and Democratic leaders on Sunday night to raise the debt ceiling that includes sharp spending cuts but no new taxes, breaking a partisan impasse that has driven the nation to the brink of a government default. It also brought to an end weeks of high drama that had consumed Washington, rattled global markets, and shaken confidence in the American political system at home and abroad.

The agreement would raise the $14.3 trillion debt limit in two stages by as much as $2.4 trillion. On the surface, it represents a victory for Obama, allowing him to avoid another gruelling fight over the debt limit in the heat of the 2012 presidential campaign.

President Obama said the agreement would allow US to avoid default and end the crisis that Washington had imposed. It also ensures that the US will not face this same crisis again in six months, or eight months, or 12 months. And it will begin to lift the cloud of debt and the cloud of uncertainty that hangs over our economy.”

But it is far from clear whether he would have an easy sailing in his re-election bid and recapture the White House in 2013. Many commentators have serious doubts about a positive outcome for Obama, in part because he failed to secure his other top priorities, including fresh measures to revive the flagging recovery and an end to tax breaks for corporations and the wealthy.

In fact, there is a palpable sense of outrage among the liberal Democrats, Obama’s most ardent followers. They believe the President betrayed their trust by capitulating to the Republican blackmailing. So much so that popular late nigh comedian Jay Leno lampooned Obama on his show Monday night mimicking his famous campaign slogan “Yes. We can” to “Yes. We cave”.

By contrast, it was the Republicans, especially the ultra conservative Tea Party faction, which emerged real victorious. They won severe cuts to agency budgets over the next decade and the prospect of deeper cuts to come, delivering on the campaign promises that helped them gain control of the House in 2010 Congressional elections.

The agreement would also cut agency spending by roughly $900 billion over the next decade and create a new legislative committee to come up with at least $1.2 trillion in additional savings by the end of this year. For days, the chief obstacle to a deal was the design of a mechanism to force the committee to act — or to make sure spending cuts were adopted if the committee failed.

In the end, negotiators settled on a trigger that would force automatic across-the-board cuts of $1.2 trillion to agency budgets over the next decade, split half and half between domestic programs and defence. Programs for the poor, including Medicaid and Social Security, would be exempted. But Medicare payments to providers could be hit.

It is this deep spending cuts that have most well-know economists worried about the future of the American economy. They contend that cutting spending in any form in a recession-like situation would further depress the economy instead of reviving it.

Paul Kruggman, a Nobel laureate and Prince University economist, said the debt deal was a disaster and not just for Obama and his party. In his regular column in the New York Times on Monday, he said the deal would damage an already depressed economy, it would probably make America’s long-run deficit problem worse, not better; and most important, by demonstrating that raw extortion works and carries no political cost, it would take America a long way down the road to banana-republic status.

“The worst thing you can do in these circumstances is slash government spending, since that will depress the economy even further. Pay no attention to those who invoke the confidence fairy, claiming that tough action on the budget will reassure businesses and consumers, leading them to spend more. It doesn’t work that way, a fact confirmed by many studies of the historical record.”

He argued that slashing spending while the economy is depressed won’t even help the budget situation much, and might well make it worse. On one side, interest rates on federal borrowing are currently very low, so spending cuts now will do little to reduce future interest costs. On the other side, making the economy weaker now will also hurt its long-run prospects, which will in turn reduce future revenue.

A weak domestic economy is most likely to have a profound impact on the global scenario as well. Even though the debt deal saved the United States, at least for now, from being downgraded by the rating agencies, the political histrionics that preceded the deal have eroded America’s already diminishing aura as the world’s economic haven and the sole country with the power to lead the rest of the world out of financial crisis and recession.

It has chipped away at the global authority of President Obama, who was celebrated abroad when he came to office as a man who would end an era of American unilateralism. Now the topic of discussion in other capitals is whether the Age of Obama is giving way to an Age of Austerity, one that will inevitably reduce America’s influence internationally.

Christine Lagard, the new head of the International Monetary Fund, seemed to give voice to that concern when she told CNN that in the past there was always “a positive bias towards the United States of America, towards Treasury bills.” The events of the past few weeks, she said delicately, are “probably chipping into that very positive bias.”

Jeffrey Garten, a professor at the Yale School of Management and the author of several books about American power in the era of globalisation, said the challenge for the United States will not end with this crisis.

“Even if the deal passes muster with the credit rating agencies, there is still a huge problem,” he told the New York Times.

“The problem is that we need both a fiscal strategy and a growth strategy,” he said. “And what you hear around the world is that no one is convinced we do — that we have a pathway to making the debt sustainable and to dealing with everything from our infrastructure to our education system. It seems obvious to everyone that we haven’t done anything, but veer around to avoid catastrophe.”

Warnings about American decline are nothing new of course — they have permeated American politics since Vietnam, save for a brief period in the mid-1990s after the fall of the Soviet Union, when America briefly enjoyed its status as the world’s only superpower.

While no one is predicting an imminent demise of America as a super power as long as it can maintain its vast military, but many are asking whether it would be able to sustain its hard power in the face of ballooning national debt, which now stands over $14.5 trillion and counting.

Even senior military leaders are less sanguine. Admiral Mike Mullen, the departing chairman of the Joint Chiefs of Staff, has publicly said that “the most significant threat to our national security is our debt.”

And with the American economy showing no immediate sings of a long-term recovery, the country’s national debt is simply going to go up and up.

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Arshad Mahmud is a Washington Correspondent for bdnews24.com.

People hold signs as dozens of Tea Party supporters rally near the U.S. Capitol against raising the debt limit in Washington, July 27, 2011. Photo: Reuters

As you’ve already noticed, the whole world is now focused on what happens on Aug 2 when the deadline for raising the United States current debt limit of $14.3 trillion expires. Tension is mounting all across largely because what happens in the world’s largest economy has implications for many countries including Bangladesh, which exports bulk of its readymade garments to the country.

With less than a week to go, the obvious question is whether the Republican and Democratic leaders in Congress would be able to strike a deal before Aug 2 so that the US can avoid defaulting on its debt payment.

By all indications, Congressional leaders would be forced to make a deal given the rising voters’ anger against the increasingly dysfunctional way Washington works. Recent polls show Americans are getting fed up with both Democratic and Republican Congressional leaders, as well as President Obama for their seeming inability to put their acts together.

Before I get to the disastrous impact of a default on the US economy, let me explain briefly what the debt ceiling means.

Debt ceiling is the legal limit on the amount of money the US government can borrow to pay its bills, which includes the salaries of federal employees, federal programs such as Social Security and Medicare (a health insurance program for the elderly), and principal and interest payments to bondholders.

The obvious question is why President Obama can’t raise the debt limit through an executive order. The answer is: he cannot do so even if he’s considered the most powerful man under the sun.

Under the US constitution, only Congress can authorise the federal government to borrow money. Since 1962 Congress has raised the debt ceiling 72 separate times, including 10 times in the past decade alone.

A rule adopted in 1979 had allowed the House of Representatives to automatically raise the debt limit to whatever level the budget required. But in January 2011, the House voted to repeal this rule, requiring the House to hold a separate vote to increase the debt limit.

When Obama took office in January 2009 in the midst of the biggest economic downturn since the Great Depression, US public debt stood at $10.6 trillion. This May, two and a half years later, the current debt limit of $14.3 trillion was reached.

Most analysts say that even after August 2, the Obama administration has some flexibility to continue meeting their payments at least for a few more days. Federal Reserve chairman Ben Bernanke has said that after August 2, the Treasury will prioritise payments on federal debt.

You may wonder why the world’s richest country needs to borrow so much money from foreign governments like China, Japan and Saudi Arabia.

The answer is simple. For many years now, the US imports much more than it exports, leaving a huge deficit in its balance of payment. No wonder, it needs to borrow money to finance its expenditure. The deficit kept growing over the years for many reasons including the wars in Iraq and Afghanistan.

In the wake of the financial crisis of 2008, the government spending soared when bailout and stimulus bills were passed in efforts to rescue and reinvigorate the US economy. Meanwhile, the recession caused tax revenues to slump. With less revenue and more expenses, the deficit grew. To meet these shortfalls, the US government borrowed more money, adding to the national debt.

The problem goes back further, though. In 2001 and 2003 George W. Bush signed into law tax bills that lowered the top marginal income tax rate from 39.6 percent to 35 percent, and slashed the top capital gains tax rate from 20 percent to 15 percent. As a result, according to a USA Today analysis, the percentage of income that Americans are paying in taxes is at its lowest level since 1950.

Meanwhile, the wars in Afghanistan and Iraq swelled the deficit. Health care is another big cost: The amount that the US government spent annually on Medicare increased by 137 percent from 1999 to 2009. According to the US treasury, the national debt has risen by more than $500 billion each year since 2002.

Now let me explain the looming disaster that can befall the US and the global economy in the event of a default.

The other day, US treasury secretary Timothy Geithner said that if the US ends up defaulting for the first time in modern history, the effect will be “catastrophic.”

The rates on US treasury bonds would spike, making it more expensive for the US to borrow money in the future. And since US bond yields serve as a floor for other lending rates, local governments and US corporations would find it more expensive to borrow money, and Americans would have to pay more to service their mortgages.

But since the US is the world’s biggest economy, the implications of a default could be equally grave in international markets. Because the global money market — a short-term loan market used by businesses around the world to finance their operations — often requires assets to be backed by US treasury instruments, a US bond default could cause this market to freeze up, as it did in September 2008 when Lehman Brothers collapsed.

Finally, the US dollar would almost certainly decline in value.

The looming disaster is sending shockwaves through the markets all over. Major rating agencies have already begun sounding alarm bells. On July 15, Standard & Poor’s warned that it could cut the US’ coveted AAA credit rating if no deal is done, which could limit some investors’ ability — and willingness — to lend to the US government. Even if the US does continue to pay bondholders, if investors refuse to buy US bonds, that could cause panic on the markets, forcing a default.

At this point, it seems highly unlikely that any budget deal will include substantial tax revenue increases. Instead, spending cuts will comprise a much larger part of a deal.

The US economy remains anaemic, with unemployment hovering above 9 percent. Although the US stock market has recovered strongly since its nadir in March 2009, wages have not risen, and consumer spending remains weak.

And that is the biggest concern for countries like Bangladesh, which depends heavily on exports to the US market. Just think of the scenario in which Americans are forced to tighten their belt and stop purchasing shirts and trousers. In that event, Bangladesh garment industry will take a direct hit.

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Arshad Mahmud is a Washington Correspondent for bdnews24.com.