Debt Ceiling Impasse – July 15, 2011

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The Obama Administration and the Republicans are currently “deadlocked” over the imperative need to raise the $14.29 trillion borrowing limit by the August 2 deadline. It is worth recalling that Congress has raised the limit a number of times in past years. While the media is making much of the impasse which arguably could be political posturing by both sides aimed at their voters, chances that the US will not default appears to be the likely outcome. This is because there is too much at stake both for the US and the global community if the obverse happens.

For all the travails that the US economy has been subjected to since 2008, it still remains the largest economy in the world with a $14 trillion GDP. Also critically, the US dollar serves as a global currency. A default by the US- because of lack of funds to pay its domestic financial obligations plus its creditors – will represent a financial tsunami. The entire global system will be thrown out of gear as foreign governments and private investors try to jettison their US bonds. In that eventuality, President Obama has already cautioned that there will not be enough money to send out Social Security checks to retirees in August. That comment must have had a positive impact on both Republican and Democratic law makers to work harder toward a compromise involving both tax cuts dear to President Obama, and a curb on spending dear to Republicans.

Another significant development was the signal by credit rating agencies that they were moving closer to an unprecedented downgrade of the US government’s debt. The Moody’s Investor Service was reviewing the US government’s top Aaa bond rating for a downgrade citing according to it of the “rising probability,” that the government’s borrowing limit would not be raised soon enough to prevent the US from running out of money to pay its bills. Similarly the Standard and Poor rating agency has reportedly told law makers privately that it might cut the government’s rating if the latter fails to make any of its expected payments – including Social Security checks – even if it makes all its debt payments. A diminished credit rating would likely have an adverse effect on the appetite of foreign governments and private individuals to hold US currency and stocks assets.

Surely politicians on both sides of the aisle will be forced, their ideological stances notwithstanding, to move to a compromise embracing both tax cuts and reduced spending. Default could lead to committing economic harakiri which none of them would like to be accused of being a party to because of rigidity in their respective positions.

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