As negotiations on a debt-ceiling deal broke down again over the weekend and leaders of both parties now plan to unveil their own debt ceiling plans, Mohamed El-Erian, co-CEO of PIMCO—the world’s largest bond fund manager—is warning that even with a debit limit deal in hand, the United States’ AAA rating is still at risk.
El-Erian (left) said in a blog posting for The Huffington Post that while he believed the nation’s leadership would “stumble into a short-term compromise over the next few days—one that raises the debt ceiling and avoids a debt default” more importantly such a plan “leaves the AAA rating extremely vulnerable and does little to lift the damaging clouds hanging over the U.S. economy.”
A debt deal, he said, “will come down to the wire,” however, “the resolution will likely be temporary, and the damage will be real and long-lasting—both of which render an already worrisome situation even more difficult going forward. Indeed, by illustrating so vividly to the whole world what is ailing America, the weekend’s political theatrics should make us all worry even more about the world’s largest economy.”
El-Erian went on to say that America’s “already-fragile economic psyche and its global standing have taken a material hit. Forget about ‘animal spirits’ for now.” Instead, he wrote, “worry even more about an economy that is already having tremendous difficulty sustaining an acceptable growth momentum, and that already suffers from an unemployment crisis that is increasingly protracted in nature. Analysts will now scramble to again revise down their projections for growth, and up those for unemployment.”
Second, he warned. “The debt and deficit issues that are at the root of the debt ceiling drama are, unfortunately, a small part of a much larger set of structural impediments to employment, investment and wealth creation.” The housing sector is still languishing, he continued, “credit intermediation is uneven, infrastructure investment is lagging, job skill mismatches are increasing, and income and wealth inequalities are worsening.”
Under a plan by House Speaker John Boehner (left), R-Ohio, the budget deficit would be cut by $1.2 trillion over 10 years and the debt ceiling would be raised in two phases, according to The Wall Street Journal on Monday. The first phase would enable the government to cover its bills through the end of the year and a second in January 2012 depending on recommendations from a congressional commission, the The Journal said.
House Majority Leader Eric Cantor, R-Va., said in a statement on Friday that “time and again these [debt ceiling] talks have reached an impasse for one reason: the Democrats’ insistence on raising taxes on small businesses and working families.” Cantor went on to say that “contrary to news reports, a deal was never reached with the White House and a deal was never close with the White House—especially after the President insisted on more tax revenue after the Gang of Six plan was released.”
But Senate Majority Leader Harry Reid (left), D-Nev., said neither he nor President Obama nor House Minority Leader Nancy Pelosi will support Republicans’ “continued insistence on a short-term raise of the debt ceiling.” A short-term extension, he said in a statement, “would not provide the certainty the markets are looking for, and risks many of the same dire economic consequences that would be triggered by default itself.” Boehner’s plan, he said, “no matter how he tries to dress it up, is simply a short-term plan, and is therefore a non-starter in the Senate and with the President.”
Reid said that in an effort to reach a bipartisan compromise, the Senate is putting together a $2.7 trillion deficit reduction package “that meets Republicans’ two major criteria: it will include enough spending cuts to meet or exceed the amount of a debt ceiling raise through the end of 2012, and it will not include revenues.” Reid planned to hold a news conference Monday afternnon to unveil his proposal to lift the $14.3 trillion debt ceiling.
Read PIMCO's Bill Gross' view of what to do with the debt ceiling at AdvisorOne.