US Politics Feature: Explaining the Next Fiscal Crisis...Coming To You in 6 Weeks

(Cartoon: Monte Wolverton)

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After the recent drama and supposed escape from the "fiscal cliff", two developing stories in Washington will affect the global economy. The first is whether Congress can pass measures to address three additional fiscal dilemmas, all of which need to be resolved by the end of March. The second, a vital sub-plot in the larger play, is the intentions and aims of the Republican-controlled House of Representatives.

Near the end of February, the US Treasury will have exhausted all contingency measures to avoid breaching the debt limit, currently $16.4 trillion, and the US will immediately default on 40% of its fiscal obligations. America could still afford to pay foreign debts through its continual receipts of tax revenues. It could even fund Social Security and other low-income payment programs...provided it is willing to make cuts such as the closure of the FBI.

As the talks on raising the debt limit reach the status of Urgent, Congress will also have to address the "sequestration cuts", delayed for two months by the fiscal cliff deal. While reductions in Federal Government spending have been demanded by the Republican Party, the requirements of the sequestration --- set down in 2011 --- will be too harsh for most members of the GOP caucus. They may be happy with the 8% cuts in domestic programme, but the 9% decrease in Pentagon funding will be intolerable for all but the libertarian wing of the party.

A compromise on the lines of cutting both sectors by a lesser amount could be forged, but that is not an option for most Republicans because it counters their basic strategy on the debt ceiling. The GOP legislators have insisted that any rise in the ceiling must be accompanied by an equal amount of spending reduction. If President Obama wants $2 trillion added to the limit to cover Government expenses for two years, then Republicans want $2 trillion in cuts from Government expenditure over 10 years. The current sequestration, as drastic as it is, only cuts $1.2 trillion from the budget over that decade.

Democrats argue that the debt limit increase and a postponement of the worst of the sequestration cuts can be afforded, without harming the medium-term fiscal outlook, by raising more revenue through a reform of the tax code. Republicans are not interested in increasing revenues and --- unlike last week's deal to suspend Bush-era tax breaks on individuals making above $450,000 --- there are no immediate measures to ease the problem.

The third dilemma facing Congress is that the continuing resolution, which allows the Government to operate on a day-to-day basis, expires at the end of March. So even Republicans compromise on their principles in February to avoid the economic catastrophe of breaking the debt ceiling, the chances of an amicable arrangement in March look bleak. Conservatives will be screaming that only a shutdown --- an actual shutdown and not the threat of one --- will force Democrats to accept that Government spending must be cut in a meaningful fashion.

Compounding these three issues is the prospect of a downgrade of America's credit rating by Moody's. In a statement released last Wednesday, the agency concluded:

Although Moody's believes that the debt limit will eventually be raised and that the risk of default on Treasury bonds is extremely low, this confluence of events [debt limit and sequestration cuts] adds uncertainty to the outcome of negotiations. However, the spending measures that result from the negotiations will form part of the medium-term outlook for the budget deficit. Moody's will need to consider these measures in assessing the rating outlook. Further revenue measures may also form part of the negotiations. The debt trajectory resulting from this process is likely to determine whether the AAA rating is returned to a stable outlook or downgraded to AA1, as Moody's stated last September.

For Moody's, this is the last chance for a balanced approach to increased revenue and reduced spending, over a 10-year period, to support America's worth for credit. Even if another stopgap measure is crafted in Congress, Moody's is likely to downgrade America's credit rating, joining Standard and Poor's and risking the uncertainty of the "two out of three" criteria that investors use to determine which securities they hold.

That prospect of economic catastrophe should be enough to force politicians in Washington to compromise on a 'Grand Bargain.' So think Moody's, Standard and Poor's, a number of moderate politicians in Washington, and a host of opinion writers. But that deal is not a realistic proposition while the Republican Party in Congress wages an internal debate over the future of the country.

Conservatives believe that the current spending levels of the Federal Government, notably its growing obligations to entitlement programmes, are dooming America to a socialist-style future where only significant wealth redistribution can pay the nation's bills. To prevent their long-term nightmare, some GOP members are prepared to suffer the short-term consequences of shutdown or a debt limit breach

In recent days Republican leaders like House Speaker John Boehner and Senate Minority Leader Mitch McConnell have made comments that suggest they are moving closer to that opinion. That may just be an opening negotiating strategy to scare the White House, but it could indicate Boehner and McConnell --- unlike last week --- will not blink at going over this "cliff".