US: Debt Deal, More Smoke And Mirrors

So there's an agreement on the US debt ceiling and spending cuts?

Well, yes, but not until the Senate and the US House of Representatives approves it,

The House of Reps approved it early Tuesday morning with many Republicans voting with the Democrats.

But the spending cuts won't start immediately and the really big cuts won't start until 2013 anyway and the special Congressional Committee doesn't report on what they might be until November.

In other words, it's what the Americans call a 'boondoggle', or what we might call a fiddle or a rort.

There's a $US2.2 trillion lift in the debt ceiling and spending cuts of around $US2.4 trillion.

Just look at the broad numbers: America has $US14.3 trillion of debt, so these are not significant.

And, in 18 months time the debt will rise to close to $US16 trillion or more, very few of the cuts will have been applied, if at all and the reality will be no change.

This might not rise as much in the next 10 years time because of the optimistic spending cuts, but it won't cut the debt in a meaningful way.

And the US economy won't be growing dramatically for the next five years or more because of the debt burden, so reducing unemployment and boosting tax revenues for the central government will take longer, putting more pressure on debt.

It's a con job designed to stop the unpalatable happening, and it is highly political, designed by the Democrats and some mainstream Republicans to put enormous pressure on the maverick Tea Party Republicans in the US House of Representatives and effectively destroy their credibility.

Markets rallied in relief yesterday and overnight on the news, but that ended when a spate of weak reports on the health of the important manufacturing sectors of Europe and the US disappointed investors.

But markets ignored the smoke and mirrors in the proposal, the continuing uncertainty and especially the grim economic reality from Friday night's GDP report which showed that the US economy grew just 0.4% in the first three months of this year.

That's verging on contraction - and the weak first report on second quarter growth of 1.3% annual was hardly any improvement (and which could very well be revised to no growth at all in the next three months).

And the deal doesn't remove the threat that America's AAA credit rating could be downgraded, an action that will raise borrowing costs for a lot of companies, investors and others.

Moves on the credit rating won't come for a while as the ratings groups assess the final agreement, assuming it is approved.

The agreement reached by congressional leaders and the White House late Sunday calls up front for roughly $US1 trillion in spending cuts over 10 years. That is a meaningless $US100 billion a year.

Another $US1.5 trillion worth of deficit reduction would be based on recommendations of a new bipartisan committee.

Most of the cuts (and those they will upset) are yet to be defined.

"This will have minimal impact on the economy.

"The cuts are not there for the first couple of years, which really makes you wonder if they're really going to happen at all," Peter Morici, an economics professor at the University of Maryland told Reuters.

They will be phased in from 2013, after the Presidential and Congressional elections on the first Tuesday in November 2012.

That slow phase in (and postponement of the hard decisions) actually has a real economic benefit: it postpones the sharp cuts in spending (which will hurt the weak recovery) for more than 18 months.

So the weak US economy, which is already facing less stimulus from Federal spending over the next 18 months, won't be subjected to a more dangerous drop in spending in that time.

According to Reuters, Troy Davig, US economist at Barclays Capital, estimates that the deal would only cut $US25-30 billion from government spending in the first year, which could shave about a tenth of a percentage point off economic growth.

The $US1.5 trillion of the planned savings will be decided by the bipartisan congressional commission, leaving unanswered the question as to whether the US has the political will to tame the country's growing debt pile once and for all.

"It's not a major drag on growth but when the economy is only growing a point and a half, a lot of economists feel that this is not the right time to be finding fiscal restraint. We will be shifting from massive stimulus to massive restraint," Mr Davig was quoted as saying.

Some of the members of that committee may not be around in 2013 after the 2012 elections and the normal changes in committee structures after each election.

The Republicans could lose heavily or the Democrats could lose control of the Senate, meaning deeper and nastier cuts could emerge, or the whole deal be voted down and nothing offered in its place.

And how would the cuts be enforced on future Administrations and Congresses?

US reports have pointed out the enforcement mechanism in this latest agreement is similar to the so-called Gramm-Rudman-Hollings spending cut trigger enacted in 1985.

That law, named after its sponsors, included unrealistic spending targets that were linked to the size of the economy and Congress quickly found ways around it to the point where it was rejected in favour of the so-called pay-as-you-go rules that required both houses to find savings to pay for new spending or tax cuts.

That worked for a while, but left loopholes for anything that could be deemed emergency spending (The new scheme has similar provisions).

It eventually died and was replaced by a free for all of entitlements, earmarks and other spending rorts.

Then the GFC hit, spending soared and government revenues collapsed.

Does anyone seriously think this agreement will succeed in the poisonous political climate that rules America at the moment and for the next 18 months at least?