Long-term picture for US economy remains gloomy

Raising the US debt ceiling is merely a short-term fix, not a cure, for the ailing US budget crisis - and the national and global economies.

On Monday morning the world awoke to the news of a US debt deal. After months of overblown rhetoric and weeks of brinkmanship, Democrats and Republican in the US Congress finally produced a common framework that raises the federal borrowing limit.

The agreement - assuming it clears the last hurdle and actually becomes law - will avert a potentially catastrophic debt default, but it is a far cry from the grand bargain that the US really requires to save the faltering recovery at home and boost the world economy.

It will take some time before the details of the deal are known. What is already clear however is that the debt ceiling will rise by about US$2.1 trillion, in two stages until 2013, so beyond the 2012 presidential campaign - key Democrat demands. In exchange for these concessions, Republicans have successfully pressed for spending cuts amounting to at least US$2.5 trillion over 10 years, of which about US$1 trillion are agreed. The remaining US$1.5 trillion will be the subject of a new bipartisan Congressional committee.

Failure by that committee to agree later this year would trigger automatic cuts in programmes defended by Democrats and Republicans respectively - social security and military expenditure. Under the framework negotiated by Congress, approximately half of those cuts would be in defence spending and the other half in domestic programmes such as farm subsidies or discretionary spending (including Medicare).

On the face of it, the debt deal sounds like a sensible compromise after months of vitriolic discord. But in reality, the agreement is little more than a short-term fix that fails to cure the long-standing US addiction to debt-fuelled consumption or to address the chronic lack of strategic investment.

It is true that the deal seeks to reduce long-term borrowing, but not by nearly enough. None of the "sacred cows" so beloved by Democrats or Republicans will be significantly touched. For example, the US could save more than $100 billion in the next ten years by changing the cost-of-living adjustments for people on social security benefits. Non-partisan experts have shown that the existing formula overstates real inflation. But this change is anathema to Democrats.

Likewise, cuts to military spending will come predominantly from shrinking existing efforts in Iraq and Afghanistan. Prohibitively expensive procurement deals and other wasteful programmes remain firmly in place, to the delight of Republican hawks. Partisan politics and sectional interests have once again prevailed at the expense of the public good.

Short-term spending cuts that threaten the fledgling recovery will be limited, as planned savings are backloaded. But any reductions to public expenditure this year are a huge gamble. Last week's revised figures for economic growth were disastrous, and job creation in the private sector has all but ground to a halt. Further temporary stimulus is desperately needed, not in the form of expensive federal programmes but rather in terms of strategic investment, for example via community banks and local investment trusts.

Moreover, key arguments about exactly where and how to cut spending remain unresolved. Wide-ranging tax reform, to close inefficient and unjust loopholes, is not on the agenda, nor is reversal of the tax cuts for the wealthiest introduced by the Bush administration.

Once initial relief at avoiding default subsides, the economic outlook for both the US and the world economy will revert to gloom. This debt deal is more of a last-minute stitch-up than a long-term solution.

Crucially, global economies will continue to be held hostage by US partisan politics. The 2012 presidential and congressional elections will be fought over spending cuts and job creation. Both the Democrats and the Republicans are internally divided and radicalised, with centrists in both parties increasingly isolated.

But in the eyes of the American public that is fed up with Washington, President Barack Obama already looks like the main culprit, standing aside and "leading from behind" when real leadership was required. If the US President after 2012 is Republican, the reckless intransigence of the Tea Party extremists will hold the US and the world economy to ransom.

The United States may save its stellar credit rating, but political leaders and economic experts across the globe agree that much damage has already been done to US credibility. That could lead to a further capital outflow from US money markets, which are an important source of short-term funding for many businesses and financial institutions around the world.

If the US system is no longer deemed reliable, then withdrawals could yet bring about another financial crisis. The trouble is that such a credit event could intervene before a proper rebalancing of global economic power from west to east has taken place.

Worse still, there are no signs that advanced economies or emerging markets are serious enough about financial or monetary reform. New banking regulations are insufficient to avoid another credit crunch. Neither the eurozone agreement 10 days ago nor yesterday's apparent US debt deal will stabilise currency fluctuations and thereby mitigate global volatility.

Moreover, the world's leading economies are unwilling to tackle monopolies or cartels in finance, commodities, retail and other key sectors. All this reinforces the mutual dependence and collusion of governments and corporate conglomerates, at the expense of a more diversified and balanced economy that can deliver sustainable growth and long-term employment.

With the US debt deal, the world economy has stepped back from the brink. But the signs are that it will continue to teeter on the edge of another major crisis.

Adrian Pabst is lecturer in politics at the University of Kent, UK, and visiting professor at the Institut d'Etudes Politiques de Lille, France.