The US debt ceiling increase of USD 2.1 trillion came with a proposed spending cut of USD 2.4 trillion. The spending cuts will happen over a period of time, but the congress is worried on the absolute level of US debt. It is a different question whether the spending cuts will happen at all, but the main point is that the borrow and spend US policy is over for now.
The US government will become more conscious of its finances and cut down on expenditure that is considered inappropriate. What is “inappropriate” will be determined by politicians and it is a given fact that where cuts have to be made will not be made. However, there will be cuts all the same.
What does it mean for the US Dollar (USD)? Spending cuts amidst high unemployment (at 9.2% is at calendar year highs) rate is considered bad for the economy. Economic growth will fall and the US will find it more difficult to service debt. The US Federal Reserve will maintain a loose monetary policy stance to counter an expected fall in US growth. Going by this argument the USD should weaken.
The other argument is that a fiscally responsible government will strengthen the government’s balance sheet and given that the US economy is largely a service driven economy (74% of GDP), lower involvement of the US government in the economy may not dampen growth. True there could be short term contracting in growth as post 2008 crisis, the government’s involvement in the economy increased as the government cut taxes, increased public spending and took stakes in banks and insurers. However, in the longer term it will help strengthen the economy given that the US society is highly entrepreneurial.
The US is not the only economy in a debt mess. Other economies including India are all running large government debt with government involvement in growth at much higher levels than the US? Debt issues plague Euro zone countries, UK and Japan. Hence the US can actually recover faster than other countries from short term growth contractions.
The second argument holds more weight and the US Dollar will come out of its slump, which saw it losing almost 10% of its value against majors.