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About Super Coins, Cliffs, and Ceilings

15/01/2013 14:45 GMT | Updated 17/03/2013 09:12 GMT

The next fiscal crisis is set for February or March. Paul Krugman is pleading for minting a $1 trillion platinum coin to avert gloom and doom. Ideas like these help put a smile on your face in difficult times, but how will the fiscal saga really evolve?

A 31 December deadline for the so-called fiscal cliff held US politicians occupied in the last weeks of 2012 and it came down to the wire. Only on 1 January did Washington manage to pass higher taxes on the wealthiest and postpone the start of big spending cuts. The fiscal deal made the Bush tax cuts permanent for most Americans. Failure to reach a deal would have sent the economy back into recession.

However, the next fiscal cliff looms. The real showdown will be on the debt ceiling and the triggering of the spending sequester: across-the-board spending cuts now kick in on 1 March and by the middle of March the debt ceiling has to be raised.

Politics vs Economics

Chances for a meaningful deal - one that deals with structural problems like the ballooning costs of Medicare, Medicaid, and Social Security - are very slim. The Senate hasn't even passed a proper budget in four years. There remains too little of a political center in a polarised Washington to make a balanced deal to address the real problems. There's a clash between the economically sound and the politically sustainable. With postponing real reforms with the latest fiscal compromise, the balance was in favor of political sustainability this time. It looks like politics will remain the primary driver of economic policies for some time to come. Unfortunately not a very good driver.

Postponing hard decisions

The lack of trust and political sclerosis in Washington could herald darker times for the US. In the last decades, politicians could afford to make economic mistakes, because of a couple of major developments:

1) Declining inflation

2) Information revolution

3) Globalisation

4) Taking on more debt

These four and especially the debt binge made it possible to postpone painful but necessary reforms. Until a couple of years ago, "the US could take on more debt instead of tackling the underlying problems or accept lower standards of living", writes Fareed Zakaria in Foreign Affairs. Not anymore, it's like investing firm Pimco regularly writes: we live in a new normal with a jobless recovery and declining wages. In this new normal problems must be tackled head-on, because soon postponing real solutions won't be possible anymore.

Complacent markets

The million dollar question is of course when will 'soon' be? This could still take a while; it will take quite some time before the markets will start to worry seriously and drive up interest rates and put the dollar on a downward trajectory. The markets have generally ignored Washington's stalemate. To please investors, the US simply has to seem better than the Eurozone and Japan, according to Jacob Funk Kirkegaard of the Peterson Institute for International Economics. And to accomplish this hasn't been too difficult a job with the euro area caught in a recession and in a hard struggle over passing over sovereignty to Brussels, and Japan stuck in decades long political paralysis and deflation.

No mega coin, but no fiscal dive either

All this doesn't mean the US isn't facing very difficult moments the coming months. If Democrats and Republicans don't come together, Washington will risk a recession, government shutdown and a downgrade from the credit rating agencies in 2013. While new debt-ceiling mayhem approaches and people are already getting nervous again, policy wonks are floating a bizarre proposal to have President Obama mint a $1000 billion platinum coin as a way of bypassing the vicious battle in Congress.

The mega coin will not be minted. The debt ceiling will be raised and a dive from the fiscal cliff once again will be avoided. Republican house speaker Boehner is making a lot of threats, but he isn't in a very strong position to make demands. Among other things, Obama gets majority approval for his handling of the negotiations according to the latest ABC News/Washington Post poll: 52-37%. Boehner's score is reversed. Just 31% approve of his performance on the cliff talks, while 51% disapprove. The GOP hasn't as much leverage in the next rounds of cliff negotiations as it thinks. The debt ceiling battle will be settled before pandemonium breaks out in March and it will be most likely mainly on Obama's terms. But chances are that to ensure that bills are paid and outstanding debt is serviced, the two parties could agree to passing a series of small increases in the debt limit. That would mean that every few months a new fiscal battle will loom on the horizon. That wouldn't make the financial markets happy, but wouldn't generate panic either.

Troubles ahead

That the new fiscal cliff will be solved, doesn't mean the US isn't facing a crisis of great magnitude. America needs vast fiscal, entitlement, infrastructure, immigration, and education reforms in order to stay on top of the political and economic game in the coming decades. About the chances of reform success, we are less sure. It's very hard to see serious reforms advancing at this point, and certainly reforms that are commensurate with the size of the problem won't be enacted. Big obstacles ahead for the US, but for the medium term, the outlook for America is still a lot better than for Europe or Japan. Especially when the fiscal cliff and debt ceiling dust is settled and political and economic tensions in Europe flare up again.