If you are in a deep financial hole at home, don’t make unnecessary enemies abroad

Two weeks ago, an unusual outbreak of bipartisanship gripped Washington, DC, increasingly the most unlikely location for such a phenomenon. After weeks of wrangling between the Biden administration and the Republicans, back in control of the House of Representatives, Congress approved a bill to suspend the United States’ national debt ceiling after late-night sessions and just days away from the deadline beyond which the US government would be forced to stop making payments to both its citizens and its creditors. This would not have been only a calamity for American citizens dependent on Medicare and Medicaid, or US government employees and serving military personnel on the government payroll, but also for the international economy with rising interest rates and a blow to the US bond market and investments. US President Biden rightly spoke of “a crisis averted”. Given these stakes, large majorities in both the Republican and Democratic ranks were ready to agree on a compromise, which secured surprisingly comfortable majorities: in the House 314 to 117 and in the Senate 63 to 36. 

The US is unique among the Western democracies in having a congressionally mandated and therefore legally binding national debt limit – previously set at US $31.4tn. As no US administration in recent times has made any serious or sustained effort to reduce the debt by curbing government spending, we are treated every few years to this ritual cliffhanger of the risk of a US default. As the deadline looms both Republicans and Democrats seize the opportunity to put pressure on the other side, the Republicans by demanding swingeing spending cuts as the price of their consent, and the Democrats by accusing the Republicans of wanting to take away social security benefits, which are vital for millions of the American poor and used by millions of retirees in the American middle class as well. Yet in the final analysis neither side has been willing to tank the US economy and compromise emerges sooner or later. This year, the fight was particularly bloody and right up to the deadline, recalling the previous last-minute standoff in 2011. This has made some commentators cynical and jaded about these budget discussions as if they are only about political posturing and the worst will never happen. Yet the process does produce every time winners and losers and a competition between Republicans and Democrats to convince their core constituencies that they have succeeded best in defending their interests. 

This time, Republicans won the concession that older Americans receiving food aid will be obliged to work. They also pushed through one of their cherished energy projects, the construction of the Appalachian gas pipeline across West Virginia, which environmentalists have long opposed. They also achieved the modification of a number of environmental laws to fast-track federal approval of new energy infrastructure. They increased the defence budget by 1% and kept the Trump-era tax cuts benefiting the wealthy and US corporations and which are set to continue until 2025. Republicans stressed during the debate that they would seek to continue these tax cuts after 2025, which puts a serious question mark over their seriousness about reducing the US debt. There were successes too for the Biden administration. The bill allows military veterans, the homeless and the young leaving foster care to be exempt from work requirements in order to claim social security benefits, and this measure will make far more Americans eligible. The bill also imposes an automatic 1% cut to US government spending across the board if Congress does not approve spending bills before the end of the fiscal year in September. This should be an incentive for both Republicans and Democrats in a divided Congress to continue to compromise. Biden has tried to cut the national debt by raising taxes on those Americans earning over $400,000 a year but this measure could not pass Congress even when the Democrats controlled both houses before last November’s midterm elections. 

As on previous occasions, the suspension of the national debt ceiling at the 11th hour has elicited deep sighs of relief from both American as well as international economists. Those who see the US as the mainstay of the liberal international order were also thankful that the US will not have to shut down its military bases across the globe due to a funding freeze. Both major political parties also congratulated themselves on the fact that the debt suspension will run until January 2025, thereby removing it as a potential flashpoint during next year’s presidential and congressional elections. The sense of a bullet dodged is once again palpable even if the compromise does not in any way resolve the longer-term issues surrounding the mounting national debt of the US. Indeed, in the same week that Congress finally agreed to suspend the debt ceiling, the Saudis and the Organisation of the Petroleum Exporting Countries (OPEC), meeting in Vienna, decided to cut oil output – the Saudis by one million barrels a day – in order to keep the price above $85. Germany also announced that it had negative growth for two consecutive quarters, driving the economy into a recession. The global economic outlook, especially with the war in Ukraine now well into its second year, does not look particularly rosy in facilitating the high growth rates needed to allow the US – and other industrialised countries – to pare down their debt and budget deficits without much greater budgetary discipline.

This is where the true consequences of the budget compromise become clear. The Republicans pushed for $4.8tn in savings over the next decade. They targeted in particular education, health and pandemic research and housing, which seems staggering given the social challenges facing American society in the 21st century and the country’s future resilience and economic prosperity. Even the Biden administration agreed to $3tn of savings in an effort to win over Republican moderates. As it turned out, the final compromise produced about $1.5tn of projected savings but some budget experts doubt that they will ultimately materialise as the pressures on government spending mount. On current estimates, the national debt is set to exceed €50tn within a decade. Servicing the interest on a debt of this dimension will cost the US Treasury over $1.5tn a year, which is twice the country’s defence budget. Republicans and Democrats could agree only to seek savings on the discretionary non-defence part of the US government’s spending. This represents only one-seventh of the current budget of $6.4tn – a very narrow base on which to achieve significant cuts. 

Entitlements once granted are difficult to modify, let alone withdraw as President Macron has recently experienced in France with his law to raise the retirement age from 62 to 64. It has provoked two years of massive street protests, strikes and trade union demonstrations that are only now subsiding. The US used to pride itself on having a younger population than the European Union average or Japan in terms of the ratio of workers to retirees but US society is now rapidly ageing and greying. Those aged 65 and over will rise from 34% of the population today to 46% by 2032. This will necessitate an increase in social security spending of around 67%. Moreover, Republican voters are almost as keen to hold on to their social security and Medicare payments as Democrat voters, according to a recent Reuters-Ipsos poll, with 73% in the first case and 84% in the second. It is indeed Republican presidents in modern times who have most rapidly increased the national debt notwithstanding all the balanced budget rhetoric and warnings about burdening future generations of Americans. They have justified tax cuts disproportionately, favouring the rich by claiming that these will promote investment and economic growth for the ultimate benefit of all.

The result, according to the Organization for Economic Co-operation and Development (OECD), is that the US has one of the lowest tax bases among the industrialised countries; and as the US Supreme Court Justice, Oliver Wendell Holmes, reminded us over a century ago: “taxes are the price we pay for a civilised society”. Yet during Biden’s attempts to increase taxes on those earning over $400,000 a year, budget experts also pointed out that – although useful in raising revenue – this measure in itself would be insufficient to balance the budget within a decade or begin to pare down the national debt.

As the International Monetary Fund (IMF) has pointed out in a recent report on the US economy, the current expansion in entitlements has to be halted. The IMF suggests higher ages for eligibility, means testing or premiums to be paid by wealthier Americans as well as other restrictive measures. Yet all this presupposes the capacity of the Biden administration, or any future administration, to engage Congress and the US public in a wider debate on entitlement reforms as many EU governments have had painfully to do in recent times. As Congress routinely extends tax breaks with no debate, this type of national consultation seems far off at the moment. It is also bound up with deeper, even more intractable issues, such as the entrenched and increasingly polarised nature of US politics; the rise of ideology on both the left and the right, but especially of conservative and even reactionary ideology; the widening gap between the super-rich, the middle class and the poor; the growing impact of climate change on US society and the economy; and the role of truth and facts in US politics in the age of the social media and artificial intelligence. There is also a growing debate on whether the much-heralded US Constitution – designed to liberate the new United States from British colonial rule in the late 18th century and with all its entrenched rights, propensity for divided government and checks and balances on the ability of the elected majority to move its agenda forward – is up to the challenges of 21st-century government. 

Yet beyond these fundamental questions regarding the nature of US society and how it generates and distributes its future wealth, there is the more geopolitical issue of the impact of financial insolvency on the US role in the wider world. Twenty-five years ago, the Yale historian, Paul Kennedy, enjoyed considerable success with his book: “The Rise and Fall of the Great Powers”. Kennedy analysed the slow but inexorable decline of the Spanish and British empires as the costs of sustaining them greatly exceeded the profits that they brought in. He ended his book with a chapter on the US and wondered whether “imperial overstretch” would ultimately force the superpower to turn inwards, embrace protectionism and give up its role as defender of the liberal international order. Yet 25 years on, these dire predictions of US insolvency and retreat from foreign burdens have not come to pass. The US has remained at the forefront of technological innovation, especially with the tech hub of Silicon Valley and its venture capital market, and has remained the world’s largest economy, although China may have drawn level on some calculations relying on purchasing power parities. The US still has the world’s best military and military capabilities and the largest network of bases, allies and partners. It has many of the top universities and scientific research institutes and still attracts talent from all over the globe. The dollar remains the dominant trading currency, and denial of access to Wall Street and the US market is still one of the most feared sanctions in the US diplomatic and financial toolbox. In a certain way, the end of the Cold War deprived the US of a major adversary and existential threat, leaving it with far weaker and smaller adversaries to confront and its international leadership and norm-setting role intact. The US was a massive debtor but other countries seemed happy to finance that debt and purchase US Treasury bonds. The day of reckoning predicted by Paul Kennedy seemed to be postponed indefinitely.

Indeed, aware of the US’ fraying transport infrastructure, shoddy airports, outdated IT systems, overreliance on fossil fuels, poor secondary school education achievement levels and declining skills in science, technology and engineering, successive administrations in Washington have made valiant efforts to reboot and modernise the US economy. President Biden is trying massive state investments in infrastructure and green technologies that recall former US president Eisenhower’s highway construction programme in the 1950s. Biden’s Inflation Reduction Act (IRA) will pump billions of dollars of federal spending into green investments and job creation as well as new infrastructure projects. The idea here is that federal spending, even if it increases the debt ceiling in the short term, is a better means of generating long-term growth than tax cuts for the wealthy that frequently are used to buy back equity or generate rents rather than spur new investment. Although the Europeans have worried that the large public subsidies provided to industry by the IRA to kickstart new plants and projects will persuade EU companies to move production to the US, there is a consensus that it will help to secure supply chains in the US, for instance in chip and microprocessor production, and make it competitive in new industries like electric cars and lithium batteries.

In short, the US faces major problems, including in non-economic areas such as narcotics abuse, rising obesity levels, access to health care and race relations. Yet it would be foolhardy to characterise it as ‘in decline’ or to bet against it. The ‘unipolar moment’ at the end of the Cold War may not have lasted long, but still, Washington has maintained its leadership role, albeit with more persuasion and less cracking of the whip than in the past. Moreover, the US can bounce back as it did after the Great Depression of the 1930s or the stagflation and Vietnam syndrome of the 1970s. 

Yet, when all this is said, the US is now facing a more confrontational and even dangerous world in this third decade of the 21st century. It faces two major power challengers at the same time, in the form of a reckless, imperialist Russia and a rising and self-confident China. Iran and North Korea are lesser powers but relentlessly hostile and dangerous too and the threat of international jihadism can resurface at any time. Moreover, medium-sized powers like Saudi Arabia, Türkiye or Brazil are less aligned and automatically cooperative than they used to be. China in particular will not be seen off as rapidly or as easily as the Soviet Union with its over-centralised and ossified economy and derelict Marxist ideology. China is a much more dynamic and well-resourced rival, able unlike the Soviet Union to compete durably with the US in those areas where the latter had an enormous advantage during the Cold War: advanced technology, innovation, military deep strike capabilities and economic growth sufficient to sustain a global leadership role. The Columbia University political scientist, Michael Doyle, has estimated in his recent book, “The New Cold War”, that the US alone spent $13tn (in 1990 dollars) on its Cold War contest with the Soviet Union. Winning out over China in a new Cold War economic, technological, military and ideological context could drag on much longer and cost the US ten or twenty times as much – but certainly not less. At the moment, we are not in this new Cold War situation, although Russia’s invasion of Ukraine and its increasing rapprochement with China have brought that division of the globe into competing armed camps closer. It is equally not totally in the hands of the US to avoid a new Cold War if Moscow and Beijing are determined to impose it on the liberal democracies, whatever the costs and consequences. 

Yet with all the daunting realities of US indebtedness and looming insolvency that the recent US budget fights have made manifest, it is perhaps a good moment for cool and calm heads in the Washington establishment to ask themselves whether the US really is best served by demonising China and designating Beijing as its new Cold War adversary. Given the recent history of disputes over Taiwan, clashes in the South China Sea, spy balloons flying over the US and accusations of cyber intrusions, economic bullying and unfair trade practices, this is not the time to persuade the US Congress to see China in a more positive light. Last week’s revelations about a Chinese spy station in Cuba have only added to the list of grievances. Rivalry and suspicion are guaranteed to dominate the relationship. But if the competition can remain peaceful, avoid a protracted arms race, avoid a total decoupling of the US and Chinese economies, and cost $20tn rather than $200tn to sustain – it would be vastly in the interests of both sides. There may well be some technological and economic spinoffs from arms races – as illustrated with the case of Teflon being invented in the US space competition with the Soviets – but the money wasted on avoidable confrontations greatly exceeds the money gained. 

This will undoubtedly be a politically incorrect message to convey at the present time but it may be useful for Washington policymakers and think tankers to think about possible compromises with Beijing to stave off a spiralling descent into a new Cold War. Accepting and managing a certain degree of inter-independence is better than pushing for a mutually harmful decoupling. At least, Washington and Beijing are talking again after a long freeze. This week, US Secretary of State, Antony Blinken, is embarking on the visit to Beijing that he cancelled after the spy balloon episode. In recent weeks, both US National Security Advisor, Jake Sullivan, and CIA Director, Bill Burns, have travelled to Vienna and Beijing respectively to meet privately with their Chinese counterparts. US Secretary of Defense, Lloyd Austin, was less successful in trying to engage the Chinese Defence Minister, Li Shungfen, on the margins of the recent Shangri-La security conference in Singapore. Yet Beijing did receive the US Assistant Secretary of State for Asian Affairs and a team from the US National Security Council. So, with the usual twists and turns, the dialogue is restarting and ways to de-escalate the tensions and look for areas of cooperation, together with inevitably the well-known warning signals from both sides, are back on the agenda. Thinking more long-term about strategic compromises could usefully build on any signs of progress. What could these compromises be?

First, Taiwan. Given the global catastrophe unleashed by Putin’s invasion of Ukraine,the US has every interest in preventing a Chinese invasion of Taiwan, which would inevitably draw in Washington and many of its Asia-Pacific partners. So, a return to the status quo ante would be best. China stops its constant military harassment of Taiwan and the US sticks to its non-recognition policy. In addition, the US would continue to arm Taiwan for defensive purposes but would exercise restraint to the extent that Beijing exercises restraint. For instance, in withdrawing its missiles aimed at Taiwan and respecting the demarcation line in the middle of the Taiwan Strait. The high-level political and congressional visits that have so irked Beijing would cease but lower-level engagements would continue and the US would still hold meetings with visiting Taiwanese leaders. 

Second, Washington and Beijing would engage in arms control talks to curb the nuclear missiles and warheads that they are targeting on each other. They would begin a process of reductions and limitations similar to the US-Russia START negotiations with their multiple means of verification and data exchanges. 

Third, there could be talks on preventing maritime incidents, particularly in the hot zones of the East and South China Seas and the Taiwan Strait. The US and its allies and partners could agree on routes and channels to uphold freedom of navigation and on a system of prior notification. It goes without saying that China would not have a veto on US military and commercial vessels operating in international waters. China would in turn notify the US of its own military activities in the vicinity of the US – for instance, the spy station in Cuba – or near US military bases overseas. 

Fourth, the US and China could agree on a roadmap to mutually lift the economic and trade sanctions that they have imposed on each other and agree to take their trade disputes to the World Trade Organization and its appellate panels – as the US and EU regularly do. China could agree to respect US private sector investments and intellectual property and stop its vexatious practices against US companies and their executives in China, for instance in forced technology transfer and trumped-up tax charges. The US would agree to allow Chinese tech companies, such as Huawei and TikTok, to operate freely provided they provide credible guarantees that the Chinese state will not access their data. It would also be helpful if Washington and Beijing could cooperate on the future of an Indo-Pacific trade pact which includes both rather than presenting competing visions aimed at excluding the other. 

Fifth, the China-US agreement to prevent cyber espionage, concluded already a decade ago, could be updated and improved with better verification and enforcement mechanisms. 

Sixth, Washington and Beijing could establish a joint Security Council of senior cabinet ministers and intelligence officials where vexatious issues of concern to both sides could be addressed to foster a better understanding of each side’s legitimate security needs and perceptions. For instance, Washington could use this body to raise with Beijing its recent finding that Iranian drone weapons supplied to Russian contain Chinese components. A parallel military-to-military channel of communication led by the two defence ministers and the major military commanders would also be set up to handle dangerous incidents and foster transparency on budgets, procurement, exercises and so on.

Finally, it would help if the US and China could resume their past dialogue on global challenges such as climate change, the handling of pandemics and health threats, piracy, the protection of the civilian use of space, safeguarding global critical infrastructure and terrorism. In the past, Beijing has broken off these talks the moment an incident has occurred, such as the spy balloon or Nancy Pelosi’s visit to Taipei. It has then taken months before the talks resume. So, an agreement on compartmentalising these talks on the global commons and global challenges that ring-fences them from the inevitable downsides in the bilateral relationship would be a useful step forward. 

Hawks will protest that compromise is a dirty word that lets Beijing off the hook for bad behaviour and doesn’t produce a clear winner and a clear loser. Moreover, the hawks will declare that these types of accommodation will not topple the communist regime in Beijing nor free the Uighurs or Tibetans from oppression nor transform China into a Western-style democracy. These compromises will not free the US-China relationship from friction, competition or the occasional crisis either. China will not turn nice nor accept the liberal norms-based order and US leadership of it and will continue to be an ideological and economic adversary. There will be no escape from the long haul of competition and demonstrating through concrete actions and achievements rather than rhetoric the superiority of one system over the other. But diplomacy is the art of the possible, not the impossible, and it is about achieving outcomes that are acceptable to two conflicting parties and balanced enough to be sustained over time. The most important objective is to avoid a catastrophic war and a victory that is gained only at the price of bankruptcy and ruin as happened to the United Kingdom after the two world wars of the 20th century.

To prevail against China and the authoritarians the US needs to take care of its own government and society and heal its democracy. It has to modernise its constitution and rebuild a national consensus on social responsibility and its role in the world. This does not mean isolationism or a catastrophic US retreat from global affairs but a better balance between resources spent overseas and resources spent at home. The Biden administration recognises this imperative and is beginning this long overdue rebalancing. But the budget debate underscores the enormity of the challenge. Let us hope in next year’s US elections that a majority of Americans will give Biden a second term to continue the repair job. Responsible government, in the final analysis, is only possible with responsible voters. And voodoo economics are not real economics – no matter how hard the populists may try to convince us otherwise. 

The views expressed in this #CriticalThinking article reflect those of the author(s) and not of Friends of Europe.