29 juli 2011
After the debt-ceiling standoff is resolved

By Mohamed A. El-Erian, PIMCO

Some have suggested that all the drama over the debt ceiling will be justified by the long-term benefit of forcing America to embark on medium-term plan for deficit reduction. Yet at this point, the benefits of a deal will be offset by how it was achieved.

I am confident that Washington will find a way, albeit very awkwardly, to compromise on a mini-deal, rather than a grand bargain, that raises the debt ceiling and avoids a debt default. They may even manage to evade a downgrade of the nation’s vaunted AAA credit rating, though this is much more uncertain.

But fiscal solvency is not merely a function of deficits and debt, interest rates and the profile of maturities. It is also highly sensitive to economic growth: The lower an economy’s growth rate, the higher a budget deficit is likely to be, the larger the debt accumulation, and the greater the need for yet another round of fiscal austerity to safeguard solvency. All are components of the much-feared debt trap.

The very vocal and visible recent bickering is causing more than transitory damage to U.S. growth and employment prospects. Remember, this debt crisis is not the result of an inability to pay; nor is it being forced on the United States by hesitant creditors. Rather, political posturing on what had been a relatively obscure and non-threatening legislative requirement — Congress gets to control the nation’s spending and taxes through other means each year — the debate on the debt ceiling has managed to bring forward in a very dramatic and disorderly manner fiscal challenges that lie down the road.

In this political mess, already-weak business and consumer confidence is being dealt a further blow. Companies with massive cash holdings now have yet another excuse to stay on the sidelines. Foreigners have been stunned by the political dysfunctionality of the country in which they have placed factories, whose financial instruments they buy with their savings and whose money serves as the global reserve currency.

It is a matter of days before analysts engage in yet another round of unfavorable revisions to their outlook for the U.S. economy. Already muted growth projections will be cut further. On the back of a weak second quarter, the much-hoped-for robust recovery will again be postponed. As the already subdued job-creation rate is undermined and the average duration of joblessness is lengthened, the unemployment crisis will deepen.

It is far from certain that, in forcing spending cuts, a resolution to the debt-ceiling debacle will materially improve the U.S. economic outlook. Indeed, because of the standoff’s detrimental impact on growth and employment, it could tip the United States closer to the very debt trap that reformers are seeking to prevent.

Yet all is not necessarily lost.

Washington’s squabbles have touched a national nerve. Americans are shocked by politicians’ inability to compromise and the absence of a common analysis. An increasing number of citizens are expressing deep frustration with our political process. Their main message is simple: The country deserves better, and it desperately needs more responsible economic governance.