Global investors have given American lawmakers plenty of slack to rein in long-term deficits before they enter crisis mode. Instead, the so-called “super committee” charged with the task failed to make any progress. That’s not shocking: there was even a Plan B in place. The problem is that lawmakers never faced any real urgency to get a deal done.
Seniors are not about to lose their social security benefits and companies like General Electric aren’t pulling up their stakes in Fairfield, Connecticut because the tax code is too complicated. Entitlements and taxes are powerful talking points, but they’re not life-threatening to the US fiscal position - at least not yet. Most importantly, the bond vigilantes - the traditional enforcers of fiscal discipline on sovereign states - are too busy in Europe to inflict any pain across the Atlantic.
In fact, Europe’s woes have reinforced a well-worn pattern of investors running into US government bonds at the first sign of trouble. Not even the loss of America’s AAA rating last summer has changed that. Uncle Sam can now borrow funds at around 1.95 percent for 10 years, down 60 basis points from August, when the government’s half-measures cost the nation its AAA rating. The dollar, on a trade-weighted basis, is up 5 per cent.
Yet, this most-favoured status casts doubt on whether the $1.2 trillion of automatic cuts will even be implemented on schedule. As long as the dollar is the world’s reserve currency and its debt markets are the most liquid in the world, legislators have much more freedom to avoid long-term fiscal problems that come packed with short-term political pain.
But assuming the world will always be so accommodative to sovereign dysfunction makes for a much bigger adjustment when the country does own up to its fiscal imbalances. Such shifts can happen with lightning speed.
The euro zone has been brought to its knees because investors decided in July that Italy, once considered to be roughly on par with Germany, is a bad credit. Financial markets have given the United States an opportunity to avert crisis. Unfortunately, so far, its leaders are squandering it.
