The Global market turbulence may force Washington’s politicians back into session to find real solutions to the Nation’s skyrocketing debt and deficit, according to an economics expert.
C. Fred Bergsten, director of the Peterson Institute for International Economics, said the debt-ceiling legislation Congress passed last month was just a set of procedures aimed at reducing the deficit over time but did not actually take effect by itself.
“That is not good enough,” Mr. Bergsten in an interview Tuesday. “The markets are responding in part to the failure of the legislation to take specific actions that are credible and effective.”
The US stock market dove on the back of last Friday’s news that Standard & Poor’s, one of the World’s 3 major credit rating agencies, downgraded the US credit rating for the 1st time in the Nation’s history.
“It’s a combination of things that had led to the weakness of the equity markets here in the US and Europe, and in Asian markets as well,” said Mr. Bergsten, a former assistant secretary of the US Treasury.
The factors included a bleak economic outlook in the US, policy implications from the debt-ceiling legislation and financial risks coming out of the downgrade, Mr. Bergsten said.
“We focus a lot in the discussion about the downgrade and the debt-ceiling legislation,” he said, “but maybe the most important development over the last couple of weeks was the sharp reduction in the estimate of the US economic growth.”
The US economy expanded 1.3% in Q-2 this year, below market expectations. Q-1 growth rate was revised downward to just 0.4%, the weakest since the recession ended 2 yrs ago. The revisions going back several years showed the recession had been worse than people had thought earlier.
All these come at a time when the US and Europe are under severe pressure to trim debts and deficits, which call for policies that would slow down the economy even further, Mr. Bergsten said.
“I regret the fact that the US has been downgraded,” Mr. Bergsten said, “but I think from an analytical standpoint, it’s correct.”
He said none of the downgrades were likely to have very much real economic effect, as shown in the rising prices of US Treasury bonds in recent days.
The downgrade would have made US Treasury bills less attractive to investors and resulted in the rise of interest rates. But the fact is that there are few attractive alternatives for investors.
Mr. Bergsten said the Euro was a natural alternative but Europe has its problems, so there had been little willingness to move out of USDs to Euros.
Other currencies; the Yen, the Australian Dollar, the Canadian Dollar, increasingly the RMB , a still pretty small in terms of their accessibility, he said.
“The same thing is true in the housing market,” Mr. Bergsten said. “I don’t think the downgrade of Fannie and Freddie would have very much further adverse effects on the housing market.”
The prolonged and unedifying debt debate of the past few months offers further evidence of Washington’s inability to work together to address big issues in a highly polarized political environment.
“Our political process has failed to deal effectively with our budget problem,” Bergsten said. “Therefore, the U.S. budget deficit is on a totally unsustainalbe trajectory over the next five, 10, 20 years.”
However, politicians could still find real solutions to the economic and fiscal chaos, “but probably only in response to sharp pressures from the market,” he said.
“I hope that these market pressures which have been so pronounced over the last few days would help focus their attention and get them back quickly to work on a real deal to cut the budget and, at the same time, strengthen the economy in the short term.” Mr. Bergsten said.
He likened the situation to the rollout of the Troubled Asset Relief Program (TARP) in Y 2008. When the Bush administration 1st proposed the TARP legislation to the Congress, the House of Representatives voted it down, and then the markets collapsed, 3 days later, the House came back and passed the legislation.
He suggested 3 things should be done to address the economic challenges. First, both parties should agree on a program that consists of tangible, concrete spending cuts and revenue increases.
Second, those measures should phase in gradually, as immediate implementation of budget cutting measures would further weaken the economy and even throw it into recession.
Third, the budget measures should deal with fundamental problems of the economy, such as increasing the retirement age for Social Security and the eligibility age for Medicare.
“Both social security and medicare programs will become insolvent over time if they are not shored up with reforms of that type,” Mr. Bergsten said.
Paul A. Ebeling, Jnr.
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Paul A. Ebeling, Jnr. writes and publishes The Red Roadmaster’s Technical Report on the US Major Market Indices, a weekly, highly-regarded financial market letter, read by opinion makers, business leaders and organizations around the world.