OBAMA ADDS FUEL TO THE CONFUSION BUT NO RESOLUTION / THE FINANCIAL TIMES COMMENTARY & ANALYSIS ( A MUST READ )

Obama adds fuel to confusion but no resolution

By Mohamed El-Erian

Published: April 13 2011 22:18


A friend and former colleague of mine, Paul McCulley, once made the distinction between those who were “responsibly irresponsible” and those who were “irresponsibly irresponsible”. The two notions explain why more unsatisfactory last-minute policy compromises are now likely, despite President Barack Obama’s impressive speech on how America must move forward to tackle its debt ceiling, and its wider problem of budgetary reform.


Mr Obama proposed cutting $4,000bn from deficits over the next 12 years, reducing government outlays to Medicare and Medicaid healthcare programmes, and even considered tax increases. His speech therefore provides an important opportunity to advance this debate, but a much broader context is still needed if it is to succeed in overcoming both domestic political stalemates and growing concerns abroad.


Back in the final quarter of 2008 and the beginning of 2009, it was right for the US to behave responsibly irresponsible. At that moment every available part of the public sector balance sheet, from the Federal Reserve’s to the Federal budget, had to be used to avoid an economic depression. And it worked.


Now one camp believes that the US should continue being responsibly irresponsible, with further fiscal and monetary stimulus to bolster a fragile recovery and avoid years of high unemployment, stagnant tax revenues, and damaging cuts in public services. This camp takes little comfort in the recent $38bn spending cuts agreement; worries that additional cuts will be required in the next few weeks to get political agreement to increase the debt limit; and feels that Mr Obama is too accommodating to the Republicans — as he was on Wednesday, in just about matching the $4,400bn in deficit reduction over a decade that some Republicans have proposed.


The other camp believes that without much sharper fiscal and monetary responsibility now the US will eventually find itself in a huge financial bind. On this view, it is just a matter of time until current policy stance leads to sharply higher interest rates, a disorderly currency, and disruptions to the availability of new capital, including from abroad.


Neither camp is likely to win out any time soon as each can draw on legitimate arguments and supporting data. As such, America’s fiscal future risks being one of further noisy disagreements and unsatisfactory and messy political compromises.


Viewed in this context, Mr Obama’s speech will, unfortunately, only add fuel to the raging debate, rather than resolve it. Republicans will attack it for including tax increases. And Democrats will oppose it for cutting social spending. Yet both sides would be well advised to consider how all this looks to the rest of the world, including some of America’s largest creditors.


The US policy muddle is of great concern globally. America’s current mix of fiscal and monetary policies are seen to contribute to global inflation, and undermine vital global public goods that the US supplies – most obviously the role of the dollar as the world’s reserve currency, and the robustness of US government bonds as the true risk-free asset of the global system.


Such concerns rarely resonate inside the US, and when they do, they are dismissed by policymakers, or blamed on other countries – for instance for not allowing their currencies to appreciate against the dollar, open up financial markets, or stimulate their own domestic demand.


But America’s government remains the world’s largest debtor, and it is running the biggest deficit. Eventually the US will be forced to come to terms with the negative global externalities its policies are creating. The question is whether to do so by choice now, or by necessity later.


If this were to materialise in the next few months, we would likely see broader support for the type of proper fiscal reform now advocated by Mr Obama. Rather than followed by repeated ad hoc spending cuts in the heat of last minute political compromises, the president’s speech could point the way to more rational medium-term budgetary reforms impacting both expenditures and revenues. Implementation would be better coordinated with the Federal Reserve, and with a view to enhancing sustainable medium-term growth. And the risk of skittishness among America’s creditors would be reduced.


The US can still choose when and how to be responsible. In this regard, Mr Obama’s speech can provide a catalyst if it is seen in its proper global context. However, should it also fall hostage to the highly polarised domestic debate, a proper medium-term fiscal plan will again be delayed and the risk will grow that responsibility will be eventually imposed on the country.


The writer is chief executive of Pimco


Copyright The Financial Times Limited 2011.