Barack Obama warns Americans will suffer without debt crisis deal

President engaged in talks with Republican leader to negotiate deal, which would mean $3tn cuts in federal spending

guardian.co.uk, Ewen MacAskill in Washington, Friday 22 July 2011

Barack Obama addresses the University of Maryland meeting on Friday,
 warning of an urgent need for a deal on US debt.
Photograph: Alex Wong/Getty Images

Barack Obama has warned of drastic consequences if America does not reach a deal on the debt crisis facing the country, saying: "If we do not solve it, every American will suffer."

With only 10 days left until the deadline, Obama and the Republican leader in the House, John Boehner, have been engaged in behind-the-scenes talks trying to negotiate a compromise. But a deal is still in doubt, facing fierce resistance from diehard Republicans in Congress – elected last year with the help of the Tea Party movement – and from left-leaning Democrats.

Speaking at a public meeting in Maryland on Friday, Obama said defaulting on its debt was not an option. "We have never defaulted on our debt and we are not going to do it now," he said. A default would be a major embarrassment to the US, with some economists warning it could trigger a new worldwide recession.

The US chamber of commerce expressed nervousness over the prospect of America's credit rating being downgraded.

A deal would see more than $3 trillion slashed from federal spending over the next decade, including farm subsidies, military spending, social security and basic medical insurance.

Federal payments to state governments could also be hit. State governors are laying down emergency plans, with California, among others, looking for alternative sources of borrowing to tide it over. Banks and businesses are also working feverishly preparing for worst-case scenarios.

The crisis is the biggest test of wills yet between Obama and hardline Republicans endorsed by the Tea Party movement. It dwarfs the stand-off earlier this year when the federal government faced shutdown.

Republicans want huge spending cuts to reduce the country's massive national debt but oppose any tax rises. Democrats have agreed to spending cuts but want to protect the poorest and to ensure that any package includes tax rises.

The US is closer to the brink than the 2 August deadline suggests. Congress would have to begin pushing through legislation by about Monday to meet that deadline.

According to the Treasury, America reached its borrowing limit of $14.3tn on 16 May but is able to keep servicing its debts until 2 August.

Mark Blyth, professor of politics at Brown University and author of the forthcoming book Austerity: The History of a Dangerous Idea, said no one knew what the impact of defaulting would be because the situation was unprecedented.

He said the US had a long-term, serious problem, given its enormous fiscal gap and dependence on China, which has been bailing the US out and which has twice expressed concern about the impact of the default crisis on its investments.

The US economy "is like Wile E Coyote who runs off the cliff and it takes him a while to realise it. What has been keeping him up is Chinese blowing air up," Blyth said.

Obama, up for re-election in November next year, has seen a sharp decline in his popularity because of the sluggishness of the US recovery from recession, with unemployment frustratingly failing to budge from just over 9%.

In spite of the negative ratings on his handling of the economy, he is doing better on the deficit issue, according to polls, with many independents, the voters who usually decide elections, blaming the Republicans and preferring a mix of spending cuts and tax increases rather than spending cuts alone.

The Democratic leader in the Senate, Harry Reid, reflecting his party's unhappiness with the tentative deal, said: "This can't be all cuts, there has to be a balance."

Credit ratings agencies such as Moody's and Standard & Poor's have put the US on notice that its triple-A rating could be downgraded, which would be a national humiliation.

A glimpse into what might happen was provided by Minnesota earlier this month when the state had to close down, with disruption reaching down even to minor elements of daily life, from beer supplies to adoption papers.

Ross Baker, professor of politics at Rutgers University, compared the US economy, with its huge debt, to a patient who needs both first aid and long-term care.

"The Democrats are the first-aid squad with their concern over the lack of money to stimulate the economy and produce jobs. The Republicans are in charge of the long-term care facility with their preoccupation with multi-generational debt levels," Baker said.

As part of this partisan battle, the House, in which the Republicans have a majority, earlier this week passed a bill to cut $5.8tn from the budget over the next 10 years. It was a symbolic move, with legislation having no chance of passing the Senate, where the Democrats have a majority.

In another symbolic move, the Senate yesterday scheduled a vote on the House bill in order to demonstrate it did not have support.

Explainer: the debt ceiling

In the past, lifting the federal debt ceiling would have passed largely unnoticed in Washington. But what makes a difference this year is that Republicans, elected with the support of the Tea Party movement, are refusing to agree unless the Obama administration makes deep cuts in spending.

The deadline for raising the $14.3tn debt limit is 2 August, according to the US Treasury. Failure to increase the limit could mean the US defaults, unable to pay its bills.

Economists are divided on what would happen next, as the situation is unprecedented, but many warn that default would have disastrous consequences not only for the US but the world economy, possibly starting a new recession.

One possibility is a short-term deal that would allow government borrowing for another eight months, in return for a more modest $1tn in cuts.

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