Power shift in US stirs worries overseas

Despite pledges to curb government spending and the huge United States budget deficit, Republicans are expected to address anxiety over unemployment and flagging growth by pushing for an extension of the income tax cuts passed during the presidency of George W Bush — a move that would add to the deficit and, by extension, further weaken the dollar.

“The rest of the world, including Asia, is looking at the US and seeing no real effective policy measures in bringing the economy back on track,” said Conference Board Chief Economist Bart van Ark.. “That is making the US lose its legitimacy in the global economic community as a leader in terms of providing solutions.”

Maintaining taxes at their current relatively low rates could help lift consumer spending in the US, while a cheaper dollar would make American exports more competitive. But analysts said those fixes would be only temporary and would be unlikely to reverse the waning of the US economic clout, as emerging markets — led by China, India and Brazil — outpace industrial nations as drivers of global growth.

A weaker dollar, by making European exports priced in euros more expensive, may also damp efforts at an export-led recovery in European countries like Britain, Greece and Ireland that have adopted harsh austerity measures to rein in their excessive debts.

After the Obama administration pushed through changes to health care and to the financial system, voters signaled that they wanted reductions in federal spending.

Representative John A Boehner, the Ohio Republican set to become the next speaker of the House, reiterated a pledge after the elections to reduce the size of government, create jobs and change the way Congress does business.

That is no easy task. Voters also want to keep expensive entitlements and are hoping Republicans can reverse cuts to the Medicare programme and extend the Bush tax cuts set to expire at year’s end.

Those moves, if enacted into law, would make it harder — not easier — to keep Republican commitments to curb the national debt and the budget deficit. From the perspective of those outside the US, “Republican claims to fiscal probity are a little difficult to buy into,” said Center for European Reform Chief Economist  Simon Tilford. “What they’re advocating would probably increase the deficit rather than effect the dramatic reduction which they claim they want to bring about.”

There is also the risk that Congress, divided between Republican control of the House and a fragile Democratic majority in the Senate, will fall into gridlock. That would leave the task of supporting a United States economic recovery almost entirely to the Federal Reserve.

The Federal Reserve expressed concern about a “slow” recovery and weak inflation in announcing plans to buy $600 billion in treasury bonds, a process known as quantitative easing, aimed at stimulating growth and reducing unemployment. That move seems certain to further weaken the dollar, but its ability to stimulate the American economy remains to be seen.

It is also unclear just how much the lame-duck Congress still controlled by Democrats can push through before the new Republican-led House takes over. But the pressure is now on the Obama administration to cut a deal on taxes before the end of the year, even though there is no consensus on where to cut spending, analysts said.

Moreover, if the current income tax rates are extended for the wealthy as well as for middle class taxpayers for the next few years, the action could add an estimated one to two per cent points to the deficit as a share of overall economic activity, according to Deutsche Bank Research Senior eonomist Klaus Günter Deutsch.

If Washington ends up adding to the deficit rather than reducing it, one result could be a further weakening of the dollar against the euro, the pound and other floating currencies. The dollar has slumped more than 15 per cent against the euro alone since June on concerns about the federal fiscal situation and on expectations that the Federal Reserve would announce new efforts to pump more money into the weakened economy.

In times of full employment, a bigger deficit can be offset by tighter monetary policy and higher interest rates, said C. Fred Bergsten, director of the Peterson Institute for International Economics in Washington. “But now, with rates at zero and the Fed about to embark on a quantitative expansion, that will mean a bigger deficit and a weaker dollar, and that’s the set of issues that would set off the biggest alarm overseas — especially among the Europeans.”

Even if the dollar continues to weaken, helping American exporters, most political and economic experts expect lawmakers from both parties to keep up pressure on China to strengthen its currency. That would make it even harder for the Obama administration to support a more cooperative approach toward bringing the Chinese currency more into line with that country’s strong economic fundamentals.

American manufacturers have long complained that China is keeping its currency, the renminbi, artificially weak, making it harder for the US exports to compete in the global marketplace. The currency issue is part of a larger skirmish over trade, said Harvard economist Kenneth S Rogoff. “If the Chinese were to give a little, that would buy a lot of time on trade policy,” he said.

“Asians especially are extremely nervous about seeing the US slap a tariff on Chinese imports or some such aggressive approach, not only because Republicans are taking the House, but because the economy is very weak.”