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People watch from above as traders work on the floor of the New York Stock Exchange on the morning of Jan. 2, 2013. (MICHAEL APPLETON/NYT)
People watch from above as traders work on the floor of the New York Stock Exchange on the morning of Jan. 2, 2013. (MICHAEL APPLETON/NYT)

Despite 'fiscal cliff' deal, U.S. braces for next fight over spending Add to ...

The nail-biting conclusion to Washington’s political drama over the “fiscal cliff” sparked a global stock-market rally, but the failure of U.S. leaders to significantly reduce the country’s $1-trillion (U.S.) deficit means the danger to the world’s largest economy is far from over.

President Barack Obama’s approval of the budget bill passed by the House of Representatives on the evening of Jan. 1 ended the threat that the consumption-driven U.S. economy would be hit by an unprecedented tax increase previously scheduled to take effect with the New Year.

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Policy makers and economists had warned that the $500-billion in new taxes, combined with $100-billion in automatic spending cuts, would derail the U.S. economic recovery and likely cause a new recession.

The last-second resolution of the so-called fiscal cliff – the term that came to describe the economic impact of those tax hikes and spending cuts – frustrated many in the U.S. capital because nearly two months of agonizing debate resulted in an agreement that was strikingly narrow in scope.

Missing from the accord between Democrats and Republicans were spending cuts that will be necessary to constrict the deficit in a significant way. Nor did the agreement lift the country’s debt limit, ensuring more political wrangling in the weeks ahead. The U.S. Treasury will reach the end of its borrowing authority at the end of February; without an agreement to raise the debt ceiling, the U.S. would default on its $16.4-trillion debt, with catastrophic consequences for the economy.

But the last attempt to raise the limit in 2011 became caught in political brinkmanship between the two parties and went down to the final hours. A repeat would undermine business and consumer confidence.

“It’s pretty depressing,” said Rudolph Penner, an economist at the Washington-based think tank Urban Institute and a former director of the Congressional Budget Office. “The good thing is we avoided big tax increases. The worst thing is we could go over the cliff two months from now.”

Global traders took a more optimistic view, as Asian markets rose with the news that 85 Republicans joined with 172 Democrats to ensure the “cliff” agreement passed the House of Representatives. The Senate approved the bill in the wee hours of New Year’s Day by a wide margin.

The response of investors to Washington’s imperfect budget deal suggests they are more focused on economic growth than a potential U.S. budget crisis. The Asian rally rolled through Europe and into North America, where the Dow Jones Industrial Average had its largest gain since December, 2011, rising more than 300 points or 2.4 per cent. In Toronto, the S&P/TSX composite index went up 107 points or 0.9 per cent. Oil and other commodities also rose, as traders bet the resolution of the fiscal dispute cleared a path for stronger growth.

Still, the market rally could be short-lived because the battle in Washington over fiscal policy has a long way to go.

The measures in the “fiscal-cliff” agreement amount to increased revenue of about $600-billion over 10 years. That only gets the United States part of the way toward stabilizing a budget deficit that has exceeded $1-trillion for four consecutive years. Until the deficit is constrained, the country’s debt, which is about 70 per cent of its economic output, will continue to grow.

The most complete studies of the U.S. fiscal situation say Congress and the White House must reduce the deficit by $4-trillion over the next 10 years. Mr. Obama accepted across-the-board spending cuts of about $1-trillion as part of the 2011 agreement to raise the debt ceiling. (The implementation of those cuts was delayed until March.)

That means lawmakers still must come up with a combination of revenue and spending reductions of more than $2-trillion.

Republican Senator Pat Toomey of Pennsylvania said his party had to be ready to do whatever it takes to get spending cuts.

“Our opportunity here is on the debt ceiling,” Mr. Toomey said on MSNBC. “We Republicans need to be willing to tolerate a temporary, partial government shutdown, which is what that could mean.”

Republicans will be eager to win deep spending cuts after suffering a political loss in the latest negotiations.

Mr. Obama wanted taxes to rise on household incomes greater than $250,000. While he gave a little to get an agreement – they will rise on individuals earning more than $400,000 and households making more than $450,000 – he still successfully forced Republican leaders to back a tax increase for the first time in two decades. He did this by campaigning, not arm-twisting in the backrooms of Congress.

But Republicans now have the debt ceiling as leverage, and they showed in 2011 that they aren’t afraid to risk the U.S.’s credit rating to use it to their political advantage.

Negotiations could follow the outline of a bigger budget deal that Mr. Obama and House Speaker John Boehner abandoned. Both signalled a willingness to raise revenue by closing loopholes and curbing tax breaks. And Mr. Obama reiterated Tuesday that he is open to reducing pension and health benefits.

 

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