WASHINGTON, (Reuters) – U.S. President Barack Obama’s speech yesterday showed he understands the “Saint Augustine” challenge of delivering fiscal frugality later, yet he offered no clear path to get there.
Obama bluntly acknowledged in his State of the Union address that trimming $400 billion off the deficit over a decade won’t fix the country’s finances. But he was short on specifics of how he would go about the necessary cuts in healthcare costs and retiree benefits, the two biggest sources of long-term fiscal strain.
More than a year-and-a-half into an economic recovery that has failed to create enough jobs for the 14.5 million unemployed, Obama’s toughest economic challenge is to support growth now while convincing creditors that the political will is there to shore up public finances later.
Economists often cite Saint Augustine — who prayed for chastity, but not yet — to describe that goal. The theory is that if investors believe the United States will address its long-term fiscal problems, borrowing costs will fall, giving the government more leeway to support the recovery now.
“To make further progress, we have to stop pretending that cutting this kind of (domestic) spending alone will be enough,” Obama said. “It won’t.”
Republicans will no doubt seize on the fact that Obama proposed only minimal spending cuts and did not mention that the country’s Treasury is only a couple of months away from bumping up against a debt ceiling mandated by Congress that will bar additional borrowing.
“Endless borrowing is not a strategy; spending cuts have to come first,” U.S. House of Representatives Budget Committee Chairman Paul Ryan said in the Republicans’ formal response to Obama. Excerpts of his prepared remarks were released in advance.
There is no doubt that budget cuts must come. By the White House’s own projections, publicly held debt will exceed 70 percent of total U.S. output by 2012 and continue rising at least through 2015 to reach levels that have caused a sovereign debt crisis in some European countries.
The question is how quickly U.S. lawmakers will take the tough decisions required. Federal Reserve Chairman Ben Bernanke made the case to the Senate Budget Committee earlier this month that adopting a credible deficit-reduction plan now would pay immediate dividends, even if it were enacted years later.
“Nobody doubts that the United States has the economic capacity to pay its bills,” Bernanke said. “It’s really a question of, do we have the political will to do that. Demonstration of political will, that’s what the markets are watching.”
What they saw yesterday may leave some doubt.
The centrepiece of Obama’s fiscal pledge was a proposal to freeze non-security discretionary spending for five years, extending a previous call for a 3-year freeze, that will cut the deficit by $400 billion over 10 years.
Ward McCarthy, chief financial economist at Jefferies & Co in New York, called the deficit reduction pledge “somewhat underwhelming in this era of $1.4 trillion budget deficits.”
Obama readily admitted that it was a only a modest step.
To put that $400 billion in perspective, it averages out to $40 billion a year — less than Americans spent at grocery stores in December 2010 alone. The $40 billion is a small fraction of one percent of U.S. economic output, and less than 3 percent of the White House’s projected 2011 deficit.
Peter Peterson, the co-founder of private equity firm Blackstone Group who is well known for his warnings about the deficit, said a spending freeze was just one element of a long-term fiscal plan.
“We must couple current efforts to stimulate the economy with a long-term plan that reduces the ballooning interest costs, which buy us nothing and crowd out deeply needed investments,” Peterson said in a statement.
THIRD RAIL
Obama has been under political pressure to pay more attention to the deficit as Republicans push for immediate spending cuts. China, the largest foreign creditor, regularly reminds the United States that it has a responsibility to get its fiscal house in order.
Some lawmakers have drawn parallels to Europe’s debt crisis and pointed to a recent rise in long-term Treasury bond rates as evidence that investors are beginning to question the U.S. fiscal position.
Treasury yields rose after Obama agreed in December to extend Bush-era tax cuts for everyone, instead of just for those earning less than $200,000 a year as he had proposed — a move that some saw as a damaging increase to the deficit. Still, many private economists say the higher rates are primarily a reflection of brighter economic prospects.
The White House has tried to draw a distinction between the short-term costs of supporting the economic recovery and the long-term task of containing healthcare costs and strengthening Social Security.
Obama touched upon both issues, but offered no concrete proposals.
His most direct point was on the tax cuts for the highest income brackets — and his comments are likely to raise tax-cutting Republicans’ hackles.
“If we truly care about our deficit, we simply cannot afford a permanent extension of the tax cuts for the wealthiest 2 percent of Americans,” said Obama. “Before we take money away from our schools, or scholarships away from our students, we should ask millionaires to give up their tax break.”