On 18th September, the Federal Reserve announced that it wasn’t about to start slowing its $85bn-a-month money printing habit? Why did the US central bank decide not to “taper”? The official line is that the Fed was worried about the impact of higher mortgage rates on the still-shaky US housing market. Fed Chairman Ben Bernanke also outlined his concern that the American labour market is weaker than it seems.
Another possible reason for the taper delay, one not cited by Bernanke, is that we’re in the “debt-ceiling season”, with Democrats and Republicans indulging in their seemingly annual game of posturing and buck-passing. Washington is playing chicken, once again, over the prospect of a US sovereign default.
“Perhaps the loss of nerve went all the way to the White House”, I wrote speculatively last week, with President Obama “deciding to take a tapering rain-check” precisely because he feared it might coincide with a particularly serious Congressional row. Since then, I’ve come to the firm conclusion that’s true.
The principle reason why the US government “bottled out” last week, opting not to retreat from its near 5-year monetary bender despite signalling it would – a decision which surprising most investors and alarmed more than a few – was that America is about to endure the mother of all fiscal stand-offs …
The UK’s party conference season is in full swing. Now the Liberal Democrats, UKIP and Labour have held their annual gabfests, the political caravan is moving to Manchester, where the Conservatives gather today. Over the summer, the entire narrative of British politics has shifted. The Westminster village now assumes a UK recovery is “in the bag” – which, for the most part, boosts the Tories. This strikes me as both misguided and astonishingly complacent.
Chancellor George Osborne has lately come close to spotting the green shots of an economic upswing, hailing “tentative signs of a balanced, broad-based and sustainable recovery”. As a British citizen, and an economist sick of writing gloomy commentaries, I so want that to be true. Yet the data is extremely patchy and, for those willing to look, some very large storm clouds are on the horizon. And, when all is said and done, I’d rather be gloomy than wrong.
Just last week, even though the Office for National Statistics left overall second quarter GDP growth unrevised at 0.7pc, the fine print was disturbing. While household spending was up 0.3pc, business investment – the underlying fuel of commerce, and a key indicator for future growth – was revised down sharply, registering a shocking 2.7pc decline. The UK economy is still 3.3pc smaller than it was five years ago, at the time of the Lehman collapse. This remains the weakest recovery in recorded British history. And now, along with the suppressed angst about unwinding so-called quantitative easing, both here and in the US, we need to consider another looming reality.
In recent days, the mood music from the States has been quite cheerful. Certainly, the deal between the US and Russia on the United Nations Security Council, several weeks in the making, has been widely and rightly welcomed as an outbreak of common sense that should not only make Middle Eastern conflict less likely but also boost global investor confidence.
Perhaps this focus on geo-politics, together with our party conferences, is one reason so little attention has been given to what’s happening in Washington – and the impact it could have. A ferocious row is brewing between the Senate, where the Democrats have a majority, and the Republican-controlled House of Representatives. Yes, I know we’ve been here before – and such spats have fizzled out. But this one may be different.
Fiscal brinkmanship seems to have been written into the American constitution in recent decades. Since the early 1980s, the “debt-ceiling” has been raised no less than 42 times, as the US national debt has ballooned from $1,390bn to $16,600bn. It’s risen by a staggering 85pc since 2008 – when Obama took office. That’s why debt-limit disputes, and budget debates more generally, have lately become so heated and partisan.
Back in the summer of 2011, the debt-limit stand-off was resolved by forcing the President to raise the ceiling in three stages, with the last two subject to Congressional votes. In February 2013, there were more shenanigans, as Congress suspended the debt-limit for three and a half months, adopting so-called “extraordinary measures” to raise it retrospectively. That’s what produced the $16,700bn ceiling now in place – and which Treasury Secretary Jacob Lew says will be breached on October 17th.
Unless a deal is done over the coming weeks, then, the US could be forced into a sovereign default, causing havoc on international markets. Faith in the world’s most widely held financial asset would be hammered, interest rates would spike as global equities nose-dived.
While few believe that will happen, previous US fiscal showdowns have sparked serious financial volatility and, two years ago, cost America its triple-A credit rating, as the world’s largest economy was downgraded for the first time. All the signs are that this budget clash will be even worse – not least as the language is so bitter.
The first flashpoint will be tomorrow. Monday night is the deadline for Congress to agree an annual “spending bill”, or budget. For the first time, the Republicans are going all out for “Obamacare”, the Democrat’s flagship health reform that many of the President’s opponents view as ideologically objectionable and ruinously expensive. The White House, in contrast, sees health reform as sacrosanct, having passed enabling laws in 2010, upheld by the Supreme Court two years later. Obama then regained the White House last year, with health care at the heart of his election message, as his party kept control of the Senate.
Republicans retort that they held their share of votes in the House, and did so while extolling the virtues of low tax and low spending. So, there is “no mandate” for higher taxes and more borrowing, many of them say. Egged on by the Tea Party – written off by most mainstream analysts, a judgment they’re now rapidly revising – a core of Republican lawmakers insist they’ll only pass a new budget on Monday if Obamacare is “de-funded” or, at the very least delayed for a year.
While financial markets may remain sanguine if budget negotiations fail over the next 24 hours, and the US government endures a temporary “shut-down”, on the other hand they may not. A mid-October debt-ceiling debacle would most certainly turn markets upside down. The GOP’s requirements for that agreeing to that go way beyond Obamacare, including demands for completion of the Keystone oil pipeline from Canada to the Gulf of Mexico, various offshore oil and gas production permits and the scrapping of other Democrat shibboleths related to environmental protection and consumer rights.
To be sure, the atmosphere in Washington is tense. When asked if he would ever abandon this fiscal struggle, Republican House Speaker John Boehner said: “I do not see that happening”.
The President, meanwhile, is spitting tacks. “No Congress before this one has ever, ever in history been irresponsible enough to threaten an economic shutdown, to threaten default … ” Obama said, “just to try to blackmail a President into giving them some concessions on issues that have nothing to do with the budget”.
America’s fiscal row, which has already delayed Fed tapering, could yet derail the broader global recovery, so upending British politics. As the Tories survey the electoral landscape, they should keep that reality in mind.
Following Liam on Twitter – @liamhalligan