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Debt deal: No cause for celebration

By Ethan Ilzetzki, Special to CNN
  • Ethan Ilzetzki is an Assistant Professor and lecturer at the London School of Economics
  • He says raising the debt ceiling should have been a "no-brainer"
  • Ilzetzki: "America's 'exorbitant privilege' has been on display in full force"

Editor's note: Ethan Ilzetzki is a lecturer (assistant professor) at the Department of Economics and Associate at the Center of Economic Performance at the London School of Economics. He has held policy and research positions at the International Monetary Fund, the U.S. Department of Treasury, and the Millennium Challenge Corporation.

(CNN) -- Agreement was finally reached between the White House and Congress in negotiations to raise the debt ceiling.

As politicians, markets, and citizens around the world breathe a sigh of relief, it is perhaps time to reflect on what we have learned from this crisis about the state of the U.S. and global economies. What was the commotion all about?

Governments across the world, but particularly in Europe, have been facing tough decisions this year. Markets have shown little patience for the accounting shenanigans of the Greek government, the high debt burdens of the Portuguese and Irish sovereigns, and large deficits in other economies.

With alternative investment options elsewhere, investors sold these countries' bonds en-masse. The high borrowing rates that ensued forced these governments into tough decisions. They were compelled to slash government spending and to increase taxes overnight.

The coalition government in Britain chose to enact austerity measures preemptively. Some have questioned the timing and urgency of these budget cuts. But at the very least they were enacted by a recently elected parliament through standard budgetary procedures, rather than under market-imposed pressure.

The contrast to the U.S. could not be greater. The U.S. did not face a debt crisis, rather a political one. Even faced with the prospect of a U.S. sovereign default and with warnings by credit agencies that U.S. debt would be downgraded, markets showed an insatiable appetite for U.S. Federal debt. The U.S. government has been able to borrow for 10 years at interest rates around 3 % and to roll over its short-term bills with virtually no interest.

Surprisingly, throughout the entire "debt crisis," U.S. bond prices have increased in price. Bond prices increased on Friday with "bad news" on progress in debt negotiations, while they declined Monday in European trading, as agreement was reached. For spectators in the crisis countries of Southern Europe, this might seem bizarre.

But these developments are indications that investors were more concerned about the steady supply of Treasury bonds and economic conditions in the U.S. than excessive U.S. public debt or a U.S. default. U.S. mutual funds, central banks in emerging markets and investors worldwide continue to view U.S. government securities as virtually the only show in town as far as safe reserve assets go. America's "exorbitant privilege" has been on display in full force.

We also learned that American politics, not only economics, could potentially send ripples across the world. Raising the debt ceiling should have been a "no-brainer." In all other democracies, deficits and debt are simply the outcome of the tax laws and budgets their legislators pass.

Congress' refusal to raise the debt ceiling was viewed worldwide as a rebellion not against economic policy or the president, but rather against Congress' own existing commitments.

Congress' intransigence was couched in terms of fiscally-responsible rhetoric. Ironically, this behavior was merely another demonstration that the U.S. system of government is unable to manage its public finances sensibly.

The sausage-making of politics is never appetizing to watch, but debt negotiations exposed deep flaws in the U.S. government's decision-making process. Pre-emptive fiscal austerity may be desirable to avoid a Greek-style sovereign default, or the panicked fiscal reversals that markets have imposed on other European economies.

But Congress' refusal to increase the debt ceiling brought the U.S. government to the brink of default or credit downgrade, rather than averting such disasters.

But agreement should be no source for celebration. Needed reforms in U.S. entitlement programs, the U.S. tax code, defense budget and other public expenditures are necessary for the long-run fiscal health of the world's largest economy.

Sweeping changes to the role of government and in tax law will affect the well being of millions of Americans and the long-run productivity of the U.S. economy. Agreement on such reforms behind closed doors at the eleventh hour is unlikely to be well thought out and even less likely to prove politically sustainable.

Sustainable solutions to America's long-term fiscal challenges are more likely to come through deliberation and public consultation, not under the pressure of an artificial deadline.

This episode has exposed the dysfunction of the American political system. It has also reminded us that the U.S. is currently the only trusted large-scale supplier of global reserve assets.

Policymakers and market participants here in Europe should be very concerned about developments across the Atlantic. We have learned that a minor sneeze in a U.S. midterm election could give the global economy far more than a cold.

The opinions expressed in this commentary are solely those of Ethan Ilzetzki.