FTSE leaps as Obama avoids budget crisis... but doubts still remain
THE London stock market soared yesterday after Barack Obama clinched an 11th-hour deal to stop the US economy plunging into crisis.
But experts warned that the agreement was only a short-term fix and more tough decisions would have to be made within weeks to deal with spending cuts and critical levels of US debt.
The FTSE 100 jumped 129.56 points to an 18-month high of 6027.37, adding £32.8billion to the value of Britain’s leading companies.
The rally was mirrored in Wall Street, Europe and Asia as investors welcomed the cross-party deal to stave off tax rises and spending cuts – the so-called fiscal cliff.
However, analysts said the US was still on the edge of a precipice as little had been done to cap government spending or deal with the country’s chronic debt.
‘Nothing really has been fixed,’ said Joseph LaVorgna, an economist at Deutsche Bank.
‘We have a lot of work to do’
‘There are much bigger philosophical issues that we aren’t even addressing yet.’
Some even compared US politicians to leaders in Europe who have failed to get a grip of the problems caused by the crisis in the eurozone.
It was feared that the fiscal cliff – the £370billion expected to be raised by tax increases and spending cuts due to kick in on January 1 if a deal had not been struck – would tip the world’s biggest economy back into recession and derail the global recovery.
The compromise took US Republicans and Deomcrats to the brink over deeply held partisan views. In one clash, John Boehner, the top Republican in the House of Representatives, reportedly told senior Senate Democrat Harry Reid to ‘go **** yourself’ in an angry exchange at the White House.
But after months of bitter negotiations a deal was struck in the early hours of yesterday when the plans were finally backed by the House of Representatives, just before the markets opened again after the Christmas and New Year’s break.
The bill saw temporary tax cuts for the majority of Americans made permanent with only those indi- viduals earning more than £250,000, or around £280,000 for couples, asked to pay more.
President Obama hailed it as a victory over Republicans who opposed any tax increases, even on the richest. He said: ‘Thanks to the votes of Republicans and Democrats in Congress I will sign a law that raises taxes on the wealthiest 2 per cent of Americans while preventing tax hikes that could have sent the economy back into recession.’
But he admitted it was ‘just one step in the broader effort to strengthen the economy’, adding: ‘We have a lot of work to do in 2013.’
The compromise, which was also welcomed by the International Monetary Fund, has merely delayed spending cuts for two months – setting up further clashes in Washington. The new deadline for agreeing spending cuts, at the end of February, will coincide with a showdown over raising the US debt ceiling from £10trillion.
Richard Lewis, head of global equities at Fidelity Worldwide Investment, described the deal as ‘deeply unimpressive’, adding: ‘The issues of the debt ceiling and spending cuts have been left for another day, actually just a few weeks away, when all this partisanship will make headlines once again.’
But it was enough to get stock markets off to a flying start in 2013. Richard Hunter, head of equities at stockbroker Hargreaves Lansdown, said: ‘For the moment it points the market in the right direction.’ Ishaq Siddiqi, a market strategist at City trading firm ETX Capital, said: ‘2013 has kicked off with a bang. Traders are piling in on the encouraging news that the US economy did not fall off the cliff. But it certainly is standing on the edge.’
Simon Denham, chief executive of City firm Capital Spreads, said: ‘All the US has managed to do is take a leaf out of the Europeans’ books by kicking the can down the road. Spending cut delays for a couple of months mean more negotiations will take place in only a few weeks and we will have to go over the same old ground again.’
Michael Ingram, a markets analyst at brokers BGC, said: ‘Had Congress done nothing it would have constituted the biggest act of economic vandalism seen in the US since the Great Depression.’
He warned that failure to reach an agreement on the debt ceiling in March would trigger ‘cardiac arrest’ on the financial markets.
Analysts warned that the US faces further downgrades to its credit rating, having been stripped of its AAA score in 2011.
Steven Englander, of investment bank Citi, said: ‘The process was so chaotic and the outcome so unsatisfactory that we are likely to see a further US downgrade.’
AFTER America postponed its jump off the fiscal cliff in the small hours of Tuesday night, world stock markets soared. Anyone listening to the BBC yesterday with its headlines praising Barack Obama would think something quite profound had changed in the world’s greatest — if battered — economy. However, it has not.
Intractable problems — chief among them chronic over- spending and weak consumer demand — have still not been solved.
The tackling of those issues has merely been postponed until the end of next month, when America’s legally enforceable ‘debt ceiling’ will probably be reached.
That will be the moment that U.S. debt passes a pre-determined point — north of $16 trillion — and a raft of dramatic public spending cuts will be triggered.
However, America’s politicians — especially its weak-willed President — may lack the guts to act even then to reduce the debt.
On Tuesday, a self- serving and pitiful compromise was reached between Republicans and Democrats to raise taxes by a small amount on the richest Americans — those earning more than £245,000 a year will pay 39.6 per cent rather than 35 per cent.
Yet those traders who propelled international markets sharply upwards as a result seem to have forgotten that America’s debt is an incomprehensible $ 16.3 trillion (£10 trillion) and that its politicians are failing to reduce it.
Instead — in a tactic copied from the EU’s crisis-hit attempts to prop up the euro — there may soon have to be yet another compromise, perhaps with an agreement to increase America’s debt ceiling again. That would damage a limping economy still further.
The rest of the world — dangerously reliant on a buoyant U.S. — should note one thing above all: the fundamentals of America’s economy are, frankly, terrible, and its international dominance is not nearly as assured as it once was.
Bribed
Its economic culture has started to change since President Obama entered the White House four years ago this month.
America more closely resembles Europe in living beyond its means and in the President’s determination to build a massive welfare state.
The danger is that none of his political opponents is powerful enough to force through the decisions that would draw the U.S. back from its economic precipice. They need to find massive spending cuts, and they won’t.
The problem is that the Democrats — who hold the Presidency and control the Senate — bribed their way to victory two months ago.
If Mr Obama had not promised to look after all his client groups, especially among minorities, he would be back home in Chicago. Now he has to pay out on those promises.
That is pretty much the way New Labour operated in Britain, by creating a vast state sector funded by the public purse that would, in return, vote for Tony Blair and later Gordon Brown.
The long-term legacy of that self- serving policy can be seen today in our disastrous national debt. The problem for America is that its per capita debt is worse even than ours.
It may be a land of opportunity with a strong work ethic (though 12 million people are unemployed and 8.2 million work part-time), but it is living seriously beyond its means.
If the debt ceiling is reached, and it is only just above that current £10 trillion debt, then automatic cuts will be enforced across the board of government budgets — which would have a knock-on effect for the rest of the world.
Britain is the biggest overseas investor in America. So when U.S. growth is feeble, we suffer because there is a falling off in demand for our exports.
While the markets rocketed yesterday, they may soon be going in the other direction if a more robust and permanent solution to this American crisis cannot be brokered.
The bigger picture, of course, is that in the past decade the U.S. has stumbled from one financial setback to another.
The American people, and, indeed, the rest of the world, urgently need to revise their view of how economically strong this ailing superpower really is.
For those who have grown up assuming that America will inevitably lead the world economically, that will come as a shock.
Personally, I believe the U.S. is at a similar point in its history to the one Britain reached in the 1890s, when Germany overtook it: the once dominant world power is entering a period of long and steady decline, as more efficient nations seek to seize pole position.
Taxes
One thing holding back American growth is its massive trade deficit, notably with China and other Asian economies.
Growth at home is essential to create the wealth to reduce debt and the annual budget deficit, which is around $1 trillion (£614 billion) a year.
The fundamental problem is that President Obama’s ballooning public sector, and the higher taxes already inflicted on small businesses, are forecast to inhibit the private sector job creation America so desperately needs to grow more quickly. Higher business taxes cut money for investment, which stops the innovation that might improve U.S. productivity and therefore help its competitiveness.
Without growth, the debt will never decline as a proportion of America’s gross domestic product.
A series of bad decisions in recent times have hobbled America. The first was when Bill Clinton asked Alan Greenspan — then running the Federal Reserve Bank — to make it easier for Americans to buy their own homes.
The result was the sub-prime mortgage disaster, in which loans were made to people with little hope of repaying them, for properties whose values collapsed.
The bursting of the dotcom bubble — the collapse in the value of internet stocks — in 2001 also destroyed much American wealth.
However, President George W. Bush depended on the traditional resilience of his country’s economy to make good the damage.
It almost did, but fighting wars in Afghanistan and Iraq made huge inroads into economic reserves and into tax revenues.
That plunge in tax receipts became worse after the collapse of Lehman Brothers in autumn 2008, which triggered a widespread economic crisis and a full-blown recession. And just as unemployment benefits started to drain the economy, the number of pensioners rose as the baby-boom generation, born after World War II, began to reach retirement.
Public debt is the equivalent of £32,000 for each of the U.S.’s 320 million or so inhabitants — or over 100 per cent of GDP. It’s a terrifying figure. When Mitt Romney ran for office last year and promised to implement the tough fiscal plan of his vice-presidential running mate, Paul Ryan, to cut the deficit and the debt, the U.S. electorate rejected him.
If they thought they could avoid a political confrontation about spending and taxes, however, they were wrong.
Risky
That is likely to come within six or eight weeks. Meanwhile, the uncertainty about how — indeed if — America is going to put its financial house in order will continue to destabilise its economy and deter investors.
Optimists say the country will pull itself up by its bootstraps, as it has before.
Certainly the advent of ‘fracking’ — extracting oil and gas cheaply from shale — must not be underestimated.
America should have cheaper energy within a few years, which will lower the costs of industrial production and distribution. But banking on that alone to rescue an economic superpower is a risky business.
What America is doing is the equivalent of putting a bill behind the clock on the mantelpiece and hoping that it will go away.
But it won’t, it will only get bigger — and if it isn’t paid, the effects will be felt far beyond American shores.