President Barack Obama is bucking austerity, betting on the United States' unique position in international bond markets to delay difficult budget cuts while pushing ahead with a handful of big-ticket spending initiatives.
The $3.7-trillion budget plan that Mr. Obama presented to Congress on Monday includes only a modest attempt at reining in one of the largest deficits on record. Even as Europe struggles with a sovereign debt crisis and Japan deals with the fallout of having its credit rating lowered, the White House is making no attempt to significantly reduce the growth of the country's debt.
Federal Reserve chairman Ben Bernanke, the International Monetary Fund, the Group of 20 economic powers and the President's own deficit-and-debt commission say the time is past to implement a credible budget that would present a path to reducing debt. Mr. Obama's budget shows that he is willing to gamble that he can keep the bond traders at bay, charting a path that mixes spending cuts with tax increases and spending on large projects such as high-speed rail and the expansion of wireless Internet to every corner of the country.
"He can get away with it for a little bit longer," said Phillip Swagel, a former chief economist at the Treasury Department who is now an economics professor at the University of Maryland. "As long as Europe struggles to get its act together, we'll be able to fund ourselves."
The U.S. plays by a different set of rules in international bond markets. As the issuer of the world's reserve currency, the Treasury can count on steady demand for its debt. The U.S. is also the dominant safe haven: When things get rocky in the global economy, investors always run for shelter under assets denominated in U.S. dollars.
The U.S. budget deficit in the fiscal year that ends Sept. 30 will be 10.9 per cent of GDP, or $1.6-trillion (U.S.). That's the biggest since 1945, when the government ran up unpaid obligations that were the equivalent of 21.5 per cent of GDP while fighting the Second World War.
Mr. Obama called his fiscal plan a "down payment" toward even tougher measures that will eventually be needed to get the country's finances in order. Despite the measures proposed on Monday, the U.S. debt still is projected to remain well above 70 per cent of gross domestic product for a decade. Research and history suggests that a debt-to-GDP ratio of 60 per cent or higher is a prelude for default.
In Europe, bond traders are forcing governments to implement harsh austerity programs by driving up their borrowing costs. Mr. Obama isn't facing that kind of pressure. Yields on U.S. 30-year bonds and 10-year notes fell Monday to relatively low rates of 4.67 and 3.62 per cent respectively.
It's with some reluctance that Prof. Swagel acknowledges that the Obama administration retains room to manoeuvre. Like Mr. Bernanke, the IMF and all the others, he said he believes the time had come for the White House to table a "credible" plan to pare the debt back to a more sustainable level.
Annual interest payments on the debt are projected to surge by 350 per cent to $928-billion by 2021. That's offsetting much of what Mr. Obama is proposing to do to reduce the deficit. A shift in market sentiment toward U.S. debt would make the situation acute. That's why Mr. Obama's fiscal commission late last year proposed a combination of spending cuts and tax increases worth about $4-trillion over 10 years. The President's proposal would reduce the deficit by $1.1-trillion in a decade.
The government needs "a much more robust package of deficit and debt reduction" than what the White House proposed, said Kent Conrad, the Democratic chairman of the Senate budget committee. "We need a comprehensive long-term debt reduction plan, the size and scope of what was proposed by the President's fiscal commission."
Mr. Obama sacrificed programs that are popular with his Democratic Party. A $2.5-billion cut in grants to help low-income earners heat their homes was among 211 budget items that are up for elimination or reduction. He proposed significant cuts to the defence budget, such as cancelling orders for C-17 transport aircraft that would save $2.5-billion. The administration would cancel dozens of tax breaks for the oil industry to recoup $46-billion over 10 years, and it would seek to raise $30-billion by charging Wall Street firms a "Financial Crisis Responsibility Fee."
But the President passed on perhaps his best opportunity yet to show that he is serious about tackling the U.S.'s fiscal challenges by leaving Medicare, Medicaid and Social Security untouched, which combined account for about 40 per cent of the budget.
The administration predicts the size of the economy will expand faster than the deficit starting in 2013, an important pivot point because the Treasury should begin collecting revenue at a pace fast enough to break the back of the deficit. But the debt will continue to rise because the cost of the federal government's health care and retirement programs will increase as the population gets older.
"We need to have a credible plan for the long-term deficit," Prof. Swagel said, comparing the current situation to avoiding a heart attack. "You know there are risk factors, but you don't know when it will happen," he said. "We should lower our risk factors as soon as we can."