Yesterday’s official announcement by Standard & Poor's that the U.S. is in danger of losing its coveted AAA credit rating is a warning shot that cannot be ignored by politicians of either party (see statement).
Both Republicans and Democrats have repeatedly stated that the current fiscal climate is unsustainable, and deficit reduction must become a priority. But huge obstacles remain.
Former Speaker of the House Nancy Pelosi and much of the far left flatly rejected the plan crafted last fall by President Barack Obama’s debt reduction commission, and Obama’s own road map to a lower deficit ignored many of his commission's proposals and only vaguely discussed entitlement spending.
Furthermore, the White House downplayed much of what S&P had to say yesterday (see story at CNBC).
That’s not much of a surprise for a group whose ideology rests on larger and larger government outlays, redistributing taxpayer dollars in a way that benefits them politically.
Conservative Republicans, however, have painted themselves into a corner by insisting that taxes cannot be part of the solution.
Though House Budget Committee Chairman Paul Ryan Paul Ryan’s bold plan took aim at Medicare and Medicaid, it ignored the trillions of dollars in unfunded liabilities facing social security. Hence, we are seeing mostly gridlock in Washington. With an election less than two years away, odds seem to favor little progress until 2013.
The status quo is unacceptable
But time is running short, and as S&P said, there is a one in three chance the U.S. will lose its triple-A credit rating if nothing is done within two years.
If a downgrade in the debt were to shake faith in the solvency of the U.S. government, bond prices would plummet, sending interest rates sharply higher, while the dollar and U.S. stocks would go into a tailspin, derailing the fragile U.S. recovery and likely sending the economy into a new and much deeper recession. That is a scenario no one wants.
Some on the right are content to dig in their heels and wait until the 2012 elections shift the balance of power in the Senate and hand them the White House. Given the number of Democratically controlled Senate seats that are up for grabs in 2012 versus those that Republican must defend, odds favor a change.
Even if Republicans win both branches of government in 2013, it seems very unlikely that the victors would have the political backbone to seriously reform entitlement spending in such a way as not to risk a major backlash by voters in 2014.
Social security, Medicare and Medicaid make up 40% of federal spending and are projected to take an increasingly large bite out of the budget. Throw in interest on the debt and other mandatory programs and we’re now talking about 60% of the federal budget!
This is simply not sustainable, and any plan that exempts entitlement spending from the budget ax would be deemed hollow.
But if newly-elected Republicans in 2013 were to send signals that entitlements would come under the knife, Democrats and their allies – if history is any guide – would lash out, raising the level of rhetoric to deafening levels.
Consequently, a bi-partisan plan that forces both parties to swallow unpalatable proposals becomes the clearest path to significant and credible spending and deficit reduction.
Gain control over spending
In my view, spending must be the focus of any credible plan to cut the budget deficit. Why? As any financial counselor or professional will tell you: debt problems don’t get solved by feeding the addict an ever-growing supply of what’s gotten him or her into trouble.
However, as a pragmatist, some give on the revenue side will have to be considered in order to forge a compromise that extends beyond one side of the political aisle.
Reducing deductions and returning some of the extra revenues in the form of lower rates might be just the formula that’s needed to win over reluctant Republicans, moderate Democrats and independent swing voters, who are growing increasingly alarmed by the prospect of a financial crisis.
A bi-partisan compromise would mostly likely be welcomed by a majority of the voting public, giving squeamish lawmakers the cover to cast politically difficult votes and put the ever-growing prospect of a financial crisis behind us.
S&P rightly pointed out in its press release yesterday, "The economy of the U.S. is flexible and highly diversified, the country's effective monetary policies have supported output growth while containing inflationary pressures, and a consistent global preference for the U.S. dollar over all other currencies gives the country unique external liquidity."
A viable debt reduction plan embraced by both parties would stand the best chance of maintaining U.S. economic leadership.
For more information about current issues impacting the economy, please see Tomorrow's Economy Today.
Also of interest, the latest jump in housing starts and building permits reported this morning.
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