America steps out of debtor's trap

The US is on the verge of passing legislation to suspend a ceiling on government debt till after next year's presidential election. Neither the Democrat nor Republican side is happy with the last-minute compromise struck to avert an economic catastrophe of the administration not being able to pay its bills. The Republicans wanted deeper spending cuts but settled for shallower ones. The Democrats did not get their way with higher taxes on the rich and companies. The agreed-upon spending freeze and tweaks to welfare entitlements should secure bipartisan support to clear both Congress and Senate in time before next week's anticipated payment defaults.

A debt default could precipitate the US recession and convulse the global economy that uses the dollar as its principal currency for trade and treasury bonds as the main foreign exchange holding. The US government has run up debts that are level with its annual economic output, and a large slice of this is held by foreign creditors. The US Federal Reserve has led a globally synchronised liquidity tightening that has pushed the dollar up against most of the world's currencies. Any disruption in trading of US securities would play havoc with global capital flows. Markets have understandably cheered initial reports about the deal with steadier bond yields and higher equity prices. Once the US debt deal is done, markets will resume their preoccupation with the Fed.

The US is still being guided into a recession by higher interest rates, and this week's deal over the debt ceiling underscores the limits of a fiscal response. Welfare spending is governed by an ageing population, and defence expenditure is hostage to strategic interests. Taxes have to mould themselves to fractured globalisation. Rising US indebtedness makes the world economy less stable because of a perverse desire abroad to seek security in the dollar. There is no way out yet of the lenders' trap, where they stand to lose more in the event of a debtor's distress.