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Who just blinked?

By MARTIN WALKER, UPI Editor Emeritus   |   Aug. 1, 2011 at 11:03 AM   |   Comments

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PARIS, Aug. 1 (UPI) -- As markets soar on the news of the debt default deal in Washington, traders might want to remember that nobody ever gave Nikita Khrushchev credit for saving the planet.

But recall the immortal words of U.S. Secretary of State Dean Rusk at the crucial moment of the Cuban missile crisis of 1962, "We were eyeball to eyeball and the other guy just blinked."

His success in that nuclear standoff is at the core of the still-potent legend of President John F. Kennedy. Khrushchev's blink, widely seen as his defeat, paved the way for the political coup that toppled him and brought his successor, Leonid Brezhnev, to power.

The interesting question is what would have happened if Khrushchev hadn't blinked, the Soviet ships had tried to steam on to Cuba with their missiles and the American submarines had sunk them. We now know that the Soviet forces on Cuba had tactical nuclear weapons at their disposal. It could have been the war to end all wars.

But Khrushchev blinked.

And what the markets and American commentators and maybe U.S. voters will remember of this weekend and the debt crisis is that U.S. President Barack Obama just blinked.

By contrast, the Republicans hung tough and prevailed. The deal is much, much more about cuts than it is about tax increases, even though most of the fiscal woes of the United States can be ascribed to the $3 trillion hole that the Bush tax cuts carved in government revenues plus the costs of the Iraq and Afghan wars.

And despite the euphoria in the markets at avoiding a debt default, there will be a price to pay for this deal.

The U.S. economy was already slowing as the various stimulus schemes began to run out. Another $300 billion in public spending goes next year in areas like accelerated depreciation. More layoffs of public employees are on the way -- and there are now 500,000 fewer state and local government employees than there were in 2008.

The new austerity is now global. On top of the savage cuts in Greece and Spain, Ireland and Italy, all the rest of the eurozone countries are committed to cutting their budget deficits to 3 percent of gross domestic product by 2013. Germany and maybe Finland and Austria can do this. Elsewhere it means more cuts.

In Britain, public spending is being cut by $100 billion in this financial year, and the result is clear -- plunging retail sales, almost zero growth and more layoffs from the banks.

In China, the central bank and finance ministry are reining in bank credit and curbing spending by local governments to fend off inflation.

All over the world, the surge in great public spending that was the universal response to the crisis of 2008 is running out and going into reverse, despite the fear that this burst of global austerity will send the world economy reeling back into recession.

Governments and central banks are faced with an impossible choice. On the one hand, if they stop public spending the economy is likely to slow yet further. On the other hand, the amount of debt that our governments have already contracted has reached terrifying levels and must somehow be brought under control.

Politicians divide along predictable lines. Fiscal conservatives say the debt is the priority and must be curbed, even at the cost of short-term pain. Fiscal liberals say that more deficit spending will do the trick, and the debt will become manageable as economies recover and tax revenues rise again.

Most economists, faced with such a dilemma, would probably say the safest course is to keep the stimulus spending going for another year or so in the hope that a recovery can be fully established, while signing in blood a pledge to cut the debt in the future.

But there is no obvious correct answer, no simple solution to this dilemma. We do, however, have two dismaying precedents.

The first comes from the United States in 1937-38, when the Roosevelt administration thought that the worst of the Great Depression was over and it could cut deficit spending. So they did, and the economy collapsed again until it was rescued by World War II.

The second precedent comes from Japan, where the bursting of the property and credit bubbles in 1991 led to two decades of zero growth and sluggish recession, despite vast amounts of deficit spending while the debt burden rose steadily toward 300 percent of GDP.

In such circumstances, when economists and central bankers dither between more debt or more depression, one should be wary of politicians who sound as though they know what they are doing and spout homilies about the government needing to balance its budget like a housewife or that debt is always a bad thing.

Above all, be wary of viewing the resolution of Washington's debt ceiling battle as a victory for the Republicans or as a defeat for Obama, who blinked. Remember that Khrushchev, by blinking, may have saved civilized life on this planet.

© 2011 United Press International, Inc. All Rights Reserved. Any reproduction, republication, redistribution and/or modification of any UPI content is expressly prohibited without UPI's prior written consent.
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