Monday, July 4, 2011

The Damage Already Being Done

Politicians, pundits and voters are working on the assumption that if a deficit reduction/debt limit deal can be brokered before the August 2 deadline, that the crisis will have been averted, our representatives will have risen to the grand occasion, and the system -- warts and all --is functioning as it is supposed to by accomondating all the conflicting interests in our diverse, complex society.

But this view does not take into account the damage that the failure to raise the debt limit (and the accompanying discussion of potential default) has already inflicted and continues to inflict every day. The drip, drip, drip that you hear is the slow, but unmistakeable, dimuntion of American power.

Our power has three main sources -- out military might (the limits of which is on display in Afghanistan, Iraq and Libya), our economy (the reputation of which took an enormous blow due to the U.S.-intitiated global financial crisis), and what I will call, the American mystique. This last item is hard to quantify, but it is real -- the notion that America is perpetually dynamic, with a people and system capable of meeting every challenge and providing leadership to the rest of the world.

While there have been many dents in our global image over the past decade, the debt limit crisis is undercutting faith in the American mystique perhaps like no other. There are two reasons:

First, since the end of World War II, confidence in American creditworthiness has been a fundamental element of the global economy and a source of stability. The bedrock of efforts to deal with any number of economic crises -- whether the oil shocks of the seventies, hyperinflation in Latin America or currency crises in Asia, has been confidence in the dollar and the bulletproof nature of American credit. The mere discussion of a possible default by the United States of America, even if it doesn't come close to happening, is terribly damaging. A lot of economics is about perception -- the thought that our Treasury bills are less than a 100% secure investment erodes global confidence in us as the backbone of the global economy.

In bygone years, this might have been just a blip. But consider that China holds $1.1 trillion in U.S. securities. The rest of the world holds another $3.3 trillion. How could it possibly be in our interest to undermine investor confidence when we are the biggest debtor nation in the history of the world? Consider as well that if we start having to pay a premium to sell our debt -- increased interest costs would wipe out the savings that are being haggled on in the debt limit talks in a nanosecond.

The second reason the debt limit stalemate is causing real damage is because it is putting our dysfunctional political system on display for the world to observe (especially for countries holding large amounts of our debt, our currency, and our equities). The power that emanates from American mystique is based on the perception that we are a can-do nation with the capability of rising up to great challenges -- coming to Europe's rescue in the war, standing up to the Soviet Union, putting a man on the moon, leading the globe into the information age. Of late, however, we are more of a can't-do nation -- we can't fix our immigration system, we can't get our economy on track, and we can't break our dependence on foreign energy sources (and we can't even talk about how to deal with climate change).

The debt limit controversy feeds into the thinking that America has lost its dynamism. It is a crazy issue after all -- one that must be difficult for the rest of the world to comprehend. Our government has set a taxation level at about 15 percent of GDP and committed to spending about 24 percent of GDP. There is no choice but to borrow the remainder. Yet, we have spent most of 2011 undermining confidence in the full faith and credit of the U.S. government while debating the foregone conclusion that we must borrow more money.

The rest of the world is left to scratch its head and wonder what is up with America.

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