US Treasury Secretary Jack Lew reckons a default by the US government would be ”catastrophic”, but don’t pencil doomsday into your diary for October 17 just yet.
The crisis over the debt ceiling and impending US default is about brinkmanship; it is about who is going to blink first, the Republicans or the Democrats. If the warring parties fail to strike a deal to lift the debt ceiling by Thursday, the US faces the ugly spectre of being unable to pay its debts. The fortunes of markets in Australia and elsewhere are inextricably entwined with the fate of the US. It is not that the US can’t pay its bills, however – it can simply raise the debt ceiling and borrow more – it is that, right now, it is unwilling to pay.
They have allowed the talk of Armageddon to play out on the public stage because urgency is a useful negotiating tool.
President Barack Obama and his negotiator Lew, and indeed their Republican counterparts, have been suitably vague about what happens next. They have allowed the talk of Armageddon to play out on the public stage because urgency is a useful negotiating tool.
The US has defaulted before. In 1979 it briefly failed to meet payments on its Treasury bills. It soon paid up. There was volatility in money markets but no catastrophe. Even if the impasse over the debt ceiling is not resolved by Thursday, government would find a means to cover its obligations.
Treasury has $US417 billion ($440 billion) in bills and bonds falling due between the October 17 deadline and November 7 – not a large amount in the scheme of things. That is not to say the prospect of default should be taken lightly. The doomsday scenario runs like this: the US runs out of cash to pay its bills, the stand-off continues, banks and investors withdraw from the money markets, and amid the ensuing crisis of confidence, banks around the world cease to lend as they did in the darkest hours of the global financial crisis four years ago.
When banks cease to lend, economies are brought quickly to a standstill. But don’t stock up on tinned food and candles yet because financial markets are not anticipating a calamity. If they were, bond yields would be far higher and share markets far lower. The most likely outcome is a deal will be struck in the next few days to extend the debt ceiling from $US16.7 trillion. Bear in mind the debt ceiling has already been extended umpteen times since it was introduced in 1917. This political din has been heard many times.
Even if there is default, it represents no fatal blow to the world economy. The spectre of economic collapse would quickly bring an end to the political impasse. Let’s not forget Wall Street banks fund the campaigns of Obama and Republican counterpart John Boehner, as well as a host of others on Capitol Hill.