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Shift in Washington Stirs Economic Jitters Abroad

As Republicans prepare to assert new authority in the U.S. Congress following the midterm elections Tuesday, the United States’ allies overseas are concerned that the political upheaval in Washington may pose fresh challenges to the global economy.

AP

Despite pledges to curb government spending and the huge U.S. budget deficit, Republicans are expected to address anxiety over unemployment and flagging growth by pushing hardest for an extension of the income tax cuts for everyone, including the rich that were passed during the presidency of George W. Bush — a move that would add to the deficit and, by extension, further weaken the U.S. dollar.

“The rest of the world, including Asia, is looking at the United States and seeing no real effective policy measures in bringing the economy back on track,” said Bart Van Ark, the chief economist at the Conference Board, which measures U.S. economic indicators. “That is making the U.S. lose its legitimacy in the global economic community as a leader in terms of providing solutions.”

Maintaining taxes at their current relatively low rates could help lift consumer spending in the United States, while a cheaper dollar would make U.S. exports more competitive. But analysts said those fixes would be only temporary and would be unlikely to reverse the waning of America’s economic might at a time when emerging markets have eclipsed industrial nations as the major drivers of the global economy.

A weaker dollar might also dampen a recovery in European countries that have adopted harsh austerity measures under pressure from financial markets to rein in their excessive debts.

After the administration of President Barack Obama pushed through costly changes to health care and to the financial system, voters signaled that they want U.S. government spending curtailed. Representative John A. Boehner, a Republican from Ohio and most likely the next speaker of the House, reiterated a pledge Tuesday to reduce the size of government, create jobs and change the way that Congress does business.

But that is no easy task: Voters also want to keep expensive entitlements and are hoping Republicans can reverse cuts to the Medicare program and extend the expiring Bush tax cuts so that taxes do not rise in a weakened economy at the end of the year.

But those moves, if enacted into law, would make it harder, not easier, to keep commitments to curb the national debt and the budget deficit. Yet they probably would not create as many jobs as would equally costly spending on big initiatives like infrastructure projects, analysts said.

From the perspective of those outside the United States, “Republican claims to fiscal probity are a little difficult to buy into,” said Simon Tilford, the chief economist at the Center for European Reform in London. “What they’re advocating would probably increase the deficit rather than effect the dramatic reduction which they claim they want to bring about.”

There is also the risk that Congress, which will be divided next year between Republican control of the House and a fragile Democratic majority in the Senate, will dissolve into gridlock. That would leave the task of supporting a U.S. economic recovery almost entirely to the Federal Reserve.

Without a healthier U.S. economy, the shift in the economic balance of power toward emerging market nations is expected to continue. Even if U.S. growth were to remain at current levels, analysts said, faster-growing markets like China, Brazil and India are now the primary drivers of the global economy, a trend underscored in a report by the International Monetary Fund last month.

It is unclear just how much the lame-duck Congress still controlled by Democrats can push through before the new Republican-led House takes over. But the pressure is now on the Obama administration to cut a deal on taxes before the end of the year, even though there is no consensus on where to cut spending, analysts said.

Moreover, if the current income tax rates are extended for the wealthy as well as for middle class taxpayers for the next few years, the action could add an estimated one to two percentage points to the deficit as a share of overall economic activity, according to Klaus Deutsch, a senior economist with Deutsche Bank Research in Berlin.

“So the need to adopt a more comprehensive fiscal adjustment package within the next two to three years becomes even more important,” he said.

If Washington ends up adding to the deficit rather than reducing it, one result could be a further weakening of the U.S. dollar against the euro, the pound and other floating currencies. The dollar has slumped more than 15 percent against the euro alone since June on concerns about the U.S. fiscal situation and on expectations that the Federal Reserve will announce new efforts Wednesday to pump more money into the weakened economy by buying Treasury securities, a process known as quantitative easing.

In times of full employment, a bigger deficit can be offset by tighter monetary policy and higher interest rates, said C. Fred Bergsten, director of the Peterson Institute for International Economics in Washington. “But now with rates at zero and the Fed about to embark on a quantitative expansion, that will mean a bigger deficit and a weaker dollar, and that’s the set of issues that would set off the biggest alarm overseas — especially among the Europeans.”

In the European Union — the world’s largest economic bloc — there is concern that a weaker dollar would make it harder to pursue an export-led recovery at a time when countries like Britain, Greece and Ireland have embraced austerity in an effort to straighten out their finances.

Even if the dollar continues to weaken, helping U.S. exporters, most political and economic experts expect lawmakers from both parties to keep up pressure on China to strengthen its currency. That would make it even harder for the Obama administration to support a more cooperative approach toward bringing the Chinese currency more into line with that country’s strong economic fundamentals.

U.S. manufacturers have long complained that China is keeping the renminbi artificially weak, making it harder for U.S. exports to compete in the global marketplace.

The currency issue is part of a larger skirmish over trade, said Kenneth S. Rogoff, a Harvard University economist and a former I.M.F. chief economist.

“If the Chinese were to give a little, that would buy a lot of time on trade policy,” he said. “Asians especially are extremely nervous about seeing the U.S. slap a tariff on Chinese imports or some such aggressive approach, not only because Republicans are taking the House, but because the economy is very weak.”

Until the dust settles, however, “unpredictability is the word of the day,” Mr. Rogoff added. “We have a powerful and volatile new force,” he added. The “rest of world will be worried about that.”

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