The Dec. 6 deal that extends unemployment benefits and the Bush-era tax breaks erases a lot of uncertainty. Its temporary payroll tax cut and semi-permanent fix for the estate tax are common-sense solutions that will help the economy.
But the deal does not help tackle fiscal deficits going forward, and it presents a huge risk: The “bond market vigilantes” may yet return with a vengeance and push the federal government to the brink of default.
It appears to us that President Barack Obama has done what he thinks he needs to do to survive until the next election cycle. He’s removed the threat of a recession induced by tax hikes and he’s disarmed some of the weapons of mass economic destruction that the GOP-led Congress might have used against him.
But these are Schwarzenegger-like fixes that take very few steps toward mending the budget mess that will be looming in 2012, when deficits and federal borrowing costs are higher and the bills will ultimately come due. They don’t, for example, deal with the looming mess of IRS Form 1099 reporting that accompanied the health care reform act.
However, there is a chance that a growing economy will produce more tax revenue and therefore minimize the size of future deficits. There is also the fact that unemployment is so high that inflation in the form of increased labor costs has been banished to the sidelines for quite a while.
That suggests interest rates also will be low, something that is absolutely essential to the U.S. Treasury’s ability to raise the money to offset the $800 billion hit from the budget compromise in its current form.
It’s just too early to count out the bond market vigilantes who could punish the U.S. Treasury severely for taking on more debt. The president is taking a high-risk gamble — history will mark him as a risk-taker who bet the farm and won big, or as an economic illiterate who didn’t understand how far up the creek he was when he turned in his paddle.