The US will pay a big price for its game of chicken

May 29, 2023

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The House Republicans gambled with the fate of the US financial system and economy, and potentially the global financial system and economy, for this?

The in-principle deal that House speaker Kevin McCarthy agreed with Joe Biden at the weekend has probably averted the prospect of the US defaulting on its debts in a week’s time when the US Treasury was expected to run out of cash.

US President Joe Biden speaks to reporters in the White House on the agreement.Credit: Bloomberg

The qualification – that the agreement probably avoids a default – is that the modest nature of the concessions McCarthy prised from Biden has already infuriated the fiscal ultra-conservatives and MAGA mavericks on the right while also causing some discontent among the progressives within the Democrat left.

It will require a coalition of Republican and Democrat centrists to push the legislation through both chambers of Congress in time to avoid a default. The tolerances, in both votes and time, are narrow.

The major threat to the bill’s passage will come from the Republicans because McCarthy has agreed to a deal which falls way short of the draconian cuts to spending in return for an increase in the $US31.4 trillion ceiling ($48 trillion) on US government debt envisaged in the bill the House narrowly passed on party lines last month.

That would have seen the ceiling raised modestly and only for a year while freezing spending at 2022 levels for a decade, which would have been equivalent to a cut approaching 15 per cent, or about $US3.2 trillion over the next decade. It would have savaged Biden’s health, climate and tax policies, slashed social welfare spending while imposing work requirements in recipients and expanded fossil fuel production.

What the House Freedom Caucus and other ultra-conservatives got was a two-year suspension of the debt ceiling (which means it won’t have to be renegotiated in an election year); an agreement that non-defence spending would remain flat next year and increase only one per cent in 2025; a 3.3 per cent increase in defence spending; a $US10 billion cut to the $US80 billion increase Congress had previously approved to the Internal Revenue Service’s budget and a more limited increase in work requirements for those receiving food stamps.

Even before the detail of the agreement was disclosed it was being described as “insanity,” “appalling” and a “surrender” by hardline Republicans.

There were those in the party who were actively advocating forcing a default unless Biden accepted the entirety of the measures included in the House’s wish list in last month’s bill, with Donald Trump, who raised the debt ceiling three times during a term as president that contributed 25 per cent of America’s entire federal government debt, encouraging them from the sidelines.

It won’t be a straightforward task for McCarthy and Senate minority leader Mitch McConnell to shepherd the legislation reflecting the weekend agreement through congress, with the limited timeframe available increasing the degree of difficulty and risk. McCarthy has said he will bring the bill to the House for a vote on Wednesday.

The disappointment within sections of his own party could even pose a threat to McCarthy’s own position, which took him 15 ballots and a host of promises to secure.

Had he done what Biden originally suggested and separated the debt ceiling issue from the normal budget negotiations that would have occurred later this year he would, given the Republicans’ House majority, probably have ended up with pretty much what he’s now presenting as a victory.

For that reason, the fiscal conservatives and the MAGA-aligned will see the outcome as a massive lost opportunity to impose their own agenda on Biden and undermine his, and his party’s, prospects in next year’s elections.

The rest of the world will breathe a sigh of relief that a deal, any deal, has been struck before the US defaults and ignites financial chaos in global markets that rely on the US Treasuries market as both the global financial safe haven and the reference point, and it many instances the legal benchmark, for a vast array of international financial assets.

Playing “chicken” with the debt ceiling – extortion might be the better description – might be routine in US politics, and routinely end with a last-minute compromise, but it is damaging to America’s reputation and its status and role in financial markets and carries actual costs.

The disappointment within sections of his own party could even pose a threat to Kevin McCarthy’s own position.Credit: AP

For weeks the yields on shorter-dated Treasury securities have been spiking – one-month bills maturing around the “X-date,” or the likely day of default, soared above 7 per cent last week having started the month below 4.5 per cent — which is a real cost to US taxpayers.

While yields are likely to fall back if the agreement is legislated, Treasury, which has been operating using extraordinary measures to conserve cash, will have to replenish its near-empty coffers and make good on the investments it suspended early this year as it became apparent the Republicans would try to use the debt ceiling to impose their own fiscal agenda on the White House.

With Treasury likely to have to raise well over $US1 trillion by then end of the year that will maintain pressure on interest rates that are already at levels not experienced in decades, spreading the pain from government to a wider range of borrowers.

The cut, in real terms, to spending next year will also probably come at the wrong time.

There is an expectation that the Federal Reserve Board’s aggressive hiking of interest rates and tightening of liquidity will, in the context of a global economic slowdown, force the US into recession. With no increase in spending allowed and the Republicans in control of the House, the White House will have no meaningful ability to respond to a downturn.

More broadly, with China and Russia doing everything they can to erode America’s geopolitical status and to undermine the role that the US dollar and US financial markets play in leveraging that influence, the preparedness of its hyper-partisan, dysfunctional political system to allow a major question mark to develop over its capacity to repay its debts is a major and damaging “own goal.”

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The US will pay a big price for its game of chicken

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