FOREIGN TRADE | 02.08.2011
World markets breathe again, but economists fret
Economists have been scrambling since Monday morning to analyze the new US debt deal and the consequences it will have for the rest of the world. What can easily be agreed upon, before the details are even read, is that themeasure aimed at averting a US default have provided much-needed breathing space for financial markets.
Ferdinand Fichtner, a macroeconomic expert at the German Institute for Economic Research (DIW), was keen to welcome the good news first. "It's good that a deal has been struck, and what is relatively positive is that it takes us to beyond the presidential election next year," he told Deutsche Welle. "That means that we'll have a bit of peace for the next couple of years, and we won't - as the Republicans were apparently pushing for - have to go through this whole tug-of-war again next spring."
Few doubt that the state of the US economy influences the health of the global economy, but whether the richest country in the world is doing well or not can have very different impacts on various parts of the world.
The United States' neighbors, for instance, are likely to feel the effects of economic changes in Washington first. "It might not be felt by Europe immediately, because the United States' trading partners are mainly in the rest of the Americas, but indirectly, the knock-on effects will be felt in Europe," said Michael Schröder, head of the international finance department at the Center for European Economic Research (ZEW).
Nuts and bolts not yet fixed
As for the deal itself, the details of how the US is going to make its savings are yet to be decided, which makes analysis speculative.
But Fichtner's first impression is skeptical. "I don't really see the deal bringing about the consolidation the US it is aspiring to," he said. "Like many others I think the US has less of a problem with expenses than with income. They should really raise taxes rather than cut expenses, but the Republicans have apparently got their way on that point."
Benedicta Marzinotto, research fellow at the Brussels-based economic think tank Bruegel, was also cautious. "It's very early to say," she told Deutsche Welle. "What will matter a lot is the composition of those spending cuts, and hence to what extent they could have a depressive impact on the rest of the economy. Fiscal consolidation in the US will have consequences for demand."
Downgraded credit
It's also far from clear what effect the credit ratings agencies' threats to downgrade Washington's triple-A rating might have on the wider economy. In the US, it could certainly be damaging. "The government would have less money, but also it could be a problem for private investors, because government bonds are often used as credit guarantees," said Fichtner. "It's a similar effect to the aftermath of the Lehman bankruptcy – you'll need more security for the same amount of credit."
If this means investment in US government bonds drops, the money would be invested elsewhere – especially in places like Switzerland and Germany. "Germany would be one of the few countries left with a triple-A rating," said Fichtner. "That means Germany, or at least the German government, would save a little more money, because it would be able to borrow money at a cheaper rate."
But others don't think it will come to this. "With any other country in the world, I would have said this will lead to higher financing costs for the state," said Schröder from the ZEW. "But with the United States I'm not so sure. Of course, the assessment of a ratings agency is very important, but it is just an opinion, after all."
"Anyone who wants to buy US government bonds can make their own judgments," he added. "The capital markets in the US are still the biggest in the world. I don't think downgrading the US to double-A would have a huge effect of financing costs."
Export pressure
Analysts say the US Federal Reserve is likely to try to counter the government's extra debts by encouraging inflation and depreciating the value of the US dollar. That could slow down European exports, and therefore the European economy.
"If the US had defaulted, there would have been appreciation of the euro, but now there is very little movement of capital from the US to Europe," said Marzinotto. "So that concern, that financial markets could turn their attention away from the US, is probably less relevant now."
China unscathed
Meanwhile, state media in China, the largest holder of US debt, chided Washington on Tuesday over the new debt ceiling, saying it was hiding "risks and troubles" for the world economy.
"Although the United States has basically avoided default, its sovereign debt problems remain unresolved," said an editorial in the People's Daily, a mouthpiece of the ruling Communist Party.
China is possesses the world's biggest foreign exchange reserves and is the largest holder of US government bonds. There are certainly long-term risks connected to this, but that doesn't mean trouble for China just yet.
"It is necessary to change the current concentration on US dollar assets, but what is more important is to change the trend of increasing holdings of dollar assets in future," Li Xiangyang, a researcher at the official Chinese Academy of Social Sciences, wrote in a separate article in the overseas edition of the People's Daily.
Fichtner said a US credit rating downgrade would not necessarily be a problem for Beijing. "China already has those US government bonds in the safe. The Chinese don't really need the money now."
In the long-term, however, China could indeed feel the pinch. "At some point, they will want to sell those bonds back, and of course their value will sink if the credit rating is downgraded," Fichtner said. "But that won't be a direct problem for the Chinese economy."
Author: Ben Knight
Editor: Sam Edmonds
Editor: Sam Edmonds
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