The U.S. fiscal cliff was dodged in pretty much the way that seemed most likely after November’s election: a bipartisan deal in which pragmatic Republicans, no longer focused on ending the presidency of Barack Obama, joined moderate Democrats to prevent economic sabotage by extremists from both ends of the political spectrum. On Wall Street, the immediate reaction was euphoria. But among mainstream economists and political commentators in Washington, it was cynicism.
While stock markets around the world approached their highest levels since the 2008 financial crisis, media headlines emphasized grim forebodings: Fresh stand-off looms after US cliff deal (Financial Times); Budget deal passes, debt ceiling looms (Wall Street Journal); Deal done but threats remain (Washington Post); Bigger showdowns loom after fiscal cliff deal (Reuters); House backs tax deal as next fight looms (Bloomberg).
Investors’ initial reactions are often misguided, especially to complex political events, but this time the markets will probably be proved right, and the pundits wrong. This week’s deal marked a genuine, and most likely sustainable, breakthrough for reasons of both politics and economics.
Politically, the bill’s decisive majorities in both houses of Congress showed that the U.S. Constitutional system is now less dysfunctional than widely believed. While ideological divisions may still be as wide as ever, November’s election transformed the political calculus for pragmatic Republicans such as John Boehner and Mitch McConnell. Instead of dedicating all their efforts to ousting Obama or wrecking his signature policies such as healthcare and financial reform, pragmatic Republicans must now consider how they might shape the president’s agenda over the next four years to protect their own vital interests and those of their constituents and financial supporters.
The most vital of these interests is to avoid another recession that would be calamitous for American businesses and workers, given the still-fragile condition of the U.S. economy and financial system.
The United States may now have, for the first time since 2009, a legislature capable of creating bipartisan majorities of pragmatic Republicans and Democrats working together on issues of fundamental importance to American voters. The more this pattern becomes established, the more it will neutralize radicals, both in the Tea Party and the Democratic left. Having compromised so many principles and suffered such acute political embarrassments during the fiscal cliff bargaining, the last thing Republican leaders will want to do is repeat the same experience in two months’ time. Future policy clashes, at least over economic policy, are likely to be less viciously adversarial, not more so, especially when the ultimate outcome of the argument is obvious and inevitable, as it was in the case of the fiscal cliff.
But will avoiding a default by the U.S. Treasury be seen as necessary and inevitable in the same way? This will depend on President Obama discovering an interest in economic policy detail that was notably absent from this recent debate and from his first term generally.
Most American voters believe, according to opinion polls, that the United States faces a grave budgetary crisis, and that public spending is rapidly rising, implying a slide towards Greek-style bankruptcy unless deficits and debts are brought under control. These statements are manifestly false.
U.S. deficits and debt, far from rising to infinity, are actually quite stable. Deficits have been halved since 2009 and will decline by about $150 billion annually in each of the next three years, according to the Congressional Budget Office. Meanwhile total debt is projected by the CBO to stabilize at around 82 percent of GDP from next year until 2018. And that is before any of the tax hikes agreed to this week. Taking account of roughly $620 billion in extra revenues raised by the fiscal cliff deal, U.S. debt will stabilize at a significantly lower GDP share and will probably do so by the middle of this year. This helps explain why the panic about national bankruptcy in Washington does not seem to affect private investors, who happily lend money to the U.S. government at the lowest interest rates on record.
Yet President Obama has made no effort to convey this reassuring information to American voters. Instead he has perpetuated the myth that the United States faces an urgent budgetary crisis, most recently in his televised speech on the fiscal cliff, when he described further deficit reductions as a top priority.
As long as voters are paranoid about a Greek-style fiscal crisis, the looming showdowns predicted by pessimistic pundits over Treasury debt limits may indeed be inevitable, since deficit hawks will argue that avoiding future national bankruptcy is even more important than avoiding an immediate default on Treasury debts. But suppose the president were to explain to voters that there is no real fiscal crisis and add that the extra revenues raised in this week’s deal make the long-term budgetary position even more secure. The threat of a confrontation over the Treasury debt limit would quickly vanish. With this threat averted, business and consumer confidence would improve, economic growth would accelerate, and government deficits would shrink rapidly, without any further major tax hikes or spending cuts.
In short, suppose President Obama decided to become a “deficit denier,” as described in this column last year. Liberals, such as Paul Krugman and Joe Stiglitz, could explain this denial as Keynesian stimulus. Conservatives could call it supply-side economics, as they did under President Ronald Reagan. Either way, deficit denial could help to avert future budget crises and accelerate economic growth.
If Barack Obama could make deficit denial a respectable position again for American politicians, as it was under Reagan, the success of his presidency would be assured.
Anatole Kaletsky is a Reuters columnist.