Friday, 22 July 2011

August 2nd...Doomsday? US Defaults on its Debt?

Hi Everyone! It has been a while since my last blog...but this is 'major news' and needs to be debated, which is why I'm writing again after 5 intensive months as a cattle rancher in South-America...I'm back in England writing at home on this interesting point.

The US 'debt ceiling'...can it go on growing...FOREVER?? 

On August 2nd. the US runs out of money...i.e. , the United States will no longer be able to pay its bills in full...and slashing spending alone won't cut it!  The U.S. government hit the debt ceiling of US $14 trillion on May 16th. Treasury Secretary Tim Geithner told Congress he would have to suspend investments in federal retirement funds until August 2nd. in order to create room for the government to continue borrowing in the debt markets.The funds will be made whole once the debt limit is increased, Geithner said in a letter.                                                      
So...what's the debt ceiling anyway?
It's a cap set by Congress on the amount of debt the federal government can legally borrow. The cap applies to debt owed to the public (i.e. anyone who buys U.S. bonds) plus debt owed to federal government trust funds such as those for Social Security and Medicare.

The ceiling is currently set at  US $14.294 trillion. The country's accrued debt hit that mark on the morning of May 16th, it is as if it has hit the limit on its credit card. Yours might be US $5,000...theirs is US $14 trillion. So going forward, until Congress agrees to raise that limit, the government needs to pay its bills in other ways.

The US government spends about US $120 billion more each month than it take in, in revenues. That's the amount Treasury needs to find somewhere!! The government has a bank account at the Federal Reserve with a little bit more than $100 billion in it. It has already used that that money! Also, by taking various extraordinary measures like suspending investments in federal retirement funds, Geithner was able to bring total debt down enough to allow the government to continue borrowing until Aug. 2.

All of these measures last until early August. That's when the government runs out of money, even under those extraordinary measures.

Ultimately, if lawmakers fail to raise the ceiling this year, they will have two choices, both awful.
They could either:
  • Cut spending or raise taxes by  several hundred billion dollars just to get through Sept. 30, which is the end of the fiscal year. 
  • Or they could acknowledge that the country would be unable to pay what it owes in full and the United States could effectively default on some of its obligations.

 The first option would be impossible to execute without serious economic repercussions. And the second option could cripple the economy and send world markets into a tailspin.

Paul O'Neill, former Treasury Secretary, has recently indicated that in order to get by the next election, i.e. November 2012...the debt ceiling would have to be raised by a whopping US $ 2 trillion more to US $16 trillion!!

However, there is a point at which investors realise that the debt is simply too much and it can't be repaid...understandably so in particular as the amount of that debt owed by foreign investors has been steadily increasing!

What happens if we get to August 2nd and there is no deal??
  • US government bondholders will be paid
  • Social Security checks could be delayed
  • Non-essential government services will be shut-down
  • Non-essential government workers will be furloughed
  • US economy would grind to a halt, increasing the odds for a double-dip recession

How likely is that to happen?
There is no provision in the US Constitution to guarantee that the US will always pay its debts, but the American Republic has proven itself for 200-plus years to be about as good a credit risk as has ever existed.
US fiscal resolve has been tested at least five times: at independence, in the war of 1812, during and after the Civil War, and in World War I and World War II. We can debate the exact fiscal pressures in each case, and precisely how various kinds of bondholders were treated, but the simple fact of the matter is that when the going gets tough, the US pays its debts.
At least in the near term, the chance that the US will not service its debt is vanishingly small – perhaps in the same order of probability as a large meteor striking the earth. To be sure, there are big fiscal questions to be sorted out – including how much the government should spend and on what, as well as how much tax it should collect and by what means.
There is also the vexing question of how much debt is too much for the modern US. In a world where international investors (from both the private and official sectors) routinely wring their hands about US fiscal deficits – and then go out and buy more US government debt – who knows the answer?
Countries never default because they can’t pay their debts; there are always ways to decrease expenditures or raise taxes. Countries default because their political processes bring them to the point where the people in power decide, for whatever reason, not to pay the government’s debts.
It is not difficult to identify who would bear what costs if the US did not pay – or if it disrupted markets by not increasing its debt ceiling. Everyone who borrows or interacts with the credit system in any way would suffer a shock that would make the crisis of 2008 look small!!
Among others, the US corporate sector – big and small business – would be livid. To be sure, executives and entrepreneurs like to shake their heads over the current US fiscal deficit. And some of them engage constructively in debates about the real issues: how to control health-care costs, prevent future financial crises, and end America’s expensive foreign wars.
But these are the issues for the presidential election of 2012, in which one hopes for debates that will set a more encouraging fiscal agenda for the next 20-30 years. How and when America’s budget problems will be resolved is unknown, but US fiscal history is encouraging – the Republic has managed and survived crisis before.
Simply put, America will not score an own goal over the debt ceiling – and John Boehner, Speaker of the United States House of Representatives, who's leading the Republican Party's charge on fiscal policy, arguing that his side needs to see 'trillions of dollars' in spending cuts in order for Congress to approve an increase in the US government’s debt ceiling is simply making threats that are not credible. 
Framing the issue this way creates a major problem for Boehner as it will directly, completely, and quickly antagonise one of the Republicans’ most important constituencies – the US corporate sector
Therefore, if Barack Obama’s administration plays its hand well, the result will be a last-minute extension of the debt ceiling with no significant concessions. It is unclear how Boehner or anyone else would be able to portray that as a political victory.

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