The US government is embroiled in a vicious fight over budget cuts and investors are becoming increasingly agitated that a truce will not be reached in time to avert a partial shutdown of the government as early as Saturday.

The situation is so critical that US president Barack Obama summoned congressional leaders to a White House meeting in a last-minute attempt to thrash out a compromise over budget cuts.

After the meeting failed to find common ground, Obama warned that a government shutdown would cause severe disruption, and would pose a threat to the country’s economic recovery.

Republican and Democrat lawmakers are in deep disagreement over spending cuts that would slice tens of billions off the 2011 budget deficit. The Republicans have proposed spending cuts of $61 billion, but Democrats say these cuts are too deep, and are instead offering $33 billion in cuts.

The talks have become urgent because the US Congress didn’t pass a budget last year, instead relying on short-term measures to keep the government running. The current stopgap budget for fiscal 2011, which began last October, is due to expire at midnight on Friday.

Republican lawmakers overnight offered to extend the existing stopgap spending measures for a further week, in exchange for an additional $12 billion in spending cuts. But Obama rejected this approach, saying the budget issue had to be resolved and he was no longer willing to accept short-term deals to keep government agencies running.

Meanwhile, the Obama administration is ramping up the pressure on Congress to raise the $14.294 trillion debt ceiling, irrespective of whether a deal for reducing US government spending can be hammered out. The US government, which is expected to run a deficit of at least $1.5 trillion this year, needs to borrow in order to fund spending, and to pay its interest bill. But the country cannot issue debt once it hits the debt ceiling.

Earlier this week, Treasury Secretary Timothy Geithner sent a nine-page letter to congressional leaders, warning that the US government would hit its debt ceiling by May 16 at the latest, and could default on its debt by July 8. A default, he said, “would cause a financial crisis potentially more severe than the crisis from which we are only now starting to recover”.

Overnight, Geithner reinforced his message, telling a Senate Appropriations subcommittee that if the US government defaulted on its debt, investors would question the country’s willingness to meet its obligations, which would shake the “foundations of the entire global financial system”.

The US economy would also be devastated. A default, he said, would “raise dramatically the borrowing costs permanently for all Americans … Unemployment will rise dramatically. Thousands, if not hundreds of thousands of businesses would fail … It would be a deeply irresponsible act. Again, inconceivable.”

Still, many Republicans are vowing to oppose any increase in the debt ceiling unless both sides can reach agreement on significant cuts in government spending.

Meanwhile, Republicans unveiled their own long-term plan for an overhaul of the US budget, which would see roughly $6 billion shaved off government spending over the next decade, compared with existing forecasts.

The plan, which was drafted by House Budget Committee chairman Paul Ryan, aims to end the “relentless government spending, borrowing and taxing that are leading America, right at this moment, towards a debt-fueled economic crisis”.

It proposes major cuts in spending on social programs and health care, particularly on Medicare, the health program for the elderly and disabled, and Medicaid, the health care programs for the poor. It also plans to cut the top individual and corporate tax rate to 25% from 35% at present. This would be funded by eliminating some existing tax breaks.

But Democrats immediately criticised the plan, saying it benefited the rich and powerful, at the expense of the rest of the country.

Investors, meanwhile, are deeply worried that the gulf between the two sides are so great that no meaningful progress will be made on reducing the US government deficit. As a result, the country will continue to plunge further into debt.

*This article first appeared at Business Spectator

Peter Fray

Save up to 50% on a year of Crikey.

This extraordinary year is almost at an end. But we know that time waits for no one, and we won’t either. This is the time to get on board with Crikey.

For a limited time only, choose what you pay for a year of Crikey.

Save up to 50% or dig deeper so we can dig deeper.

See you in 2021.

Peter Fray
Editor-in-chief of Crikey

SAVE 50%