August 1st, 2011
11:01 AM ET

A poor deal for the U.S. economy

Editor's Note: Sebastian Mallaby is the Director of the Maurice R. Greenberg Center for Geoeconomic Studies and Paul A. Volcker Senior Fellow for International Economics at the Council on Foreign Relations. The following is his First Take.

By Sebastian Mallaby, CFR.org

The U.S. debt deal announced tentatively in Washington on Sunday may have been the best that was politically possible; but it is still scarcely worthy of the name. Barring a last minute break-down in negotiations, it will save the U.S. government from defaulting on its obligations to pensioners and others. But it does not address the long-term fiscal challenges facing the nation. It does not remove the policy uncertainty that is damaging the economy. And it does not undo the severe harm to America's reputation caused by the standoff.

The package is expected to be put to the vote in both the House and Senate today. If it passes, it will put into effect $917 billion in spending cuts over ten years, with $350 billion of these cuts falling on the defense budget (for more on trends in U.S. military spending, see here ).

In one sense, these cuts are not enough. When the debt wrangling began, both sides were targeting $4 trillion of deficit reduction to get the government's finances onto a sounder footing. Officials of the credit rating agency Standard and Poor's have stressed the importance of an agreement on credible deficit reduction over the long term for the United States to keep its AAA rating. To quote a recent GeoGraphics blog post, raising the debt ceiling without a serious deficit-cutting plan “still poses risks of damaging market turmoil.”

But in another sense, the cuts may be too much. As shown in CFR's U.S. recovery chartbook, the current recovery is extremely fragile. Debt-laden households are disinclined to spend. As a result, government spending is, regrettably, a necessary driver of growth.

Smart deficit reduction would have reformed entitlement programs and eliminated loopholes in the tax code, putting government finances on a sustainable medium term path while not impacting short-term growth. Fortunately, the $917 billion of cuts are back loaded, but there is nothing in the package to counteract the drying up of recent stimulus spending and temporary tax cuts. This will exacerbate the problem of subpar GDP expansion, which in turn means that the debt-to-GDP will suffer.

In addition to the $917 billion of cuts, a special committee of lawmakers is supposed to come up with a further $1.5 trillion of deficit reduction, bringing the total to $2.4 trillion. The plan lays down a contingency that if lawmakers do not agree on reductions worth at least $1.2 trillion by December 23, a pre-set menu of cuts would take effect. But the uncertainty about how all this will play out is sure to be a drag on economic growth.

None of this will help the U.S. standing in the world. Already, outside commentators have seen the U.S. debt and the political system's clumsy handling of it as proof of American decline. A debt deal that extends the fraught politicking over deficit cuts through the end of this year is likely to keep this painful issue in the headlines. Also, the borrowing authority that the president has been granted will keep the government running only until 2013. In less than two years, this fight will resume again.

The views expressed in this article are solely those of Sebastian Mallaby. For more, visit CFR.org.

Topics: Debt Crisis • Economy • Politics • United States

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soundoff (10 Responses)
  1. Dan Mitchell

    Gas prices at $1.00 more than this time last year. We should all thank the oil companies and oil speculators for killing the economic recovery before it even had a chance to build speed.

    August 1, 2011 at 11:39 am | Reply
    • kanaka

      Yuppers

      August 1, 2011 at 1:49 pm | Reply
    • Steve

      Dan,

      Really? You place no blame that the US Dollar is the world reserve currency and all of the recent (20+ years) government borrowing (yes stimulus, tarp etc.) (yes by both dem and rep) has nothing to do with increased oil prices? Its all speculation and big oil fixing prices? Dan, come on now. Even your entry level economics class should have taught you something about money supply and reserve currencies. If you beleive your statement without having some blame put on government borrowing you are nothing but a puppet of the media and the law makers (spenders)! Go grab some education.

      August 1, 2011 at 3:38 pm | Reply
    • Coriolana

      Amen!

      August 2, 2011 at 11:34 am | Reply
  2. Onesmallvoice

    The reason this is such a bad deal for the U.S. economy is that all the budget cuts will be made in the social programs while the non productive military spending will continue to rise along with this useless foreign aid which benefits only these foreign dictators. When on takes money away from the poor and the elderly, that strips them of their buying power and in turn damages the national economy. It's that simple!

    August 1, 2011 at 1:00 pm | Reply
  3. GOPisGreedOverPeople

    GOP solution = Turn the Old, Sick, Poor, Unemployed, and Gay people into slaves. Then whip them until they are Young, Healty, Rich, Employed, and Straight. Or until they are dead. Then turn them into Soylent Green to feed the military. A self sustaining system.

    August 1, 2011 at 1:17 pm | Reply
    • Coriolana

      That sounds about right.

      August 2, 2011 at 11:35 am | Reply
  4. kanaka

    Deal or no Deal. This deal looks more like that show Make a Deal. This was no compromise, Tax Reform was not on the table as part of the compromise. Our reputation is already damaged. Separate the debt limit from the debt. Up or down on the debt limit. I don't want default either, but I would rather have default and an awakened American public so that they could see just how much their lives depend on a thriving American government which paves our roads, and picks up our garbage, cares for the elderly.
    I can guarantee that the Republicans would throw their wealthy corporate contributors under the bus as soon as we the American people start to feel the effects of this ridiculous grand plan of the GOP. These Bullies would back off as soon as the people of this country understand that their grand plan is based more upon their quest to put monitors in our bedrooms, kneel down to their God, and basically rule by some sort of Fascist principles based upon the dictate of the "Family".
    They may think they love our country, but they love themselves and their cause more and their hatred for those who disagree has overwhelmed any semblance of intelligence and common sense that they may have once had.
    They are no different than any other terrorist group.

    August 1, 2011 at 1:47 pm | Reply
    • j. von hettlingen

      This deal might just be the beginning of a tug of war in the Congress. Now the Tea Baggers must feel gratified, that they can have their way – leave the rich alone.

      August 1, 2011 at 5:51 pm | Reply
  5. fernace

    Here's what I think: no more bail outs, turn away the large corporations with their hands out for more tax subsidies in exchange for job creation. Last time they got away with this, they laid off people & sent the jobs to other countries! No more loopholes or tax exemptions for the rich! No more rolling out the red carpet for illegals! No more healthy/ able to work drug addicts living off the system! Bring our soldiers home & with them the $$ going to useless occupations! Take a look at various "research" programs & politicians pet projects & either cut funding or shut them down altogether! I think this will cut the deficit & eventually leave us with a surplus! But no1 is calling me to use my brilliant ideas! Oh, poo!!

    August 2, 2011 at 3:42 am | Reply

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