A US debt deal will be done, but it will offer only temporary respite

20 Freshmen of the House show their support for Boehner (Photo: Getty)

After another humiliating defeat for John Boehner’s bill, where are we now in the hunt for a compromise to head off US default and government shutdown? No nearer a deal, that’s where. It’s a quarter to midnight and House Republicans cannot even agree among themselves on the way forward, let alone reach an accord with the Democrat Senate. If there’s still nothing over the weekend, then we can expect markets, already jumpy enough, to be showing real signs of distress when they open first thing Monday morning.

After the markets have closed on Friday, the US Treasury is expected to announce details of what it intends to do in the event of failure to raise the debt ceiling. We have to assume it still plans to honour its debts above all other priorities. Even so, there’s talk of the Treasury preparing the ground for delayed payments. Whatever the contingency plans, the Treasury’s options are extremely limited.

There’s probably enough money left in the kitty to keep spending at current levels for a couple of weeks or so, but at some point it’s going to run out. When that happens, the Treasury will have no option but to move rapidly to bring spending into line with revenues. Almost overnight, an amount equivalent to some 8pc of GDP will have to be cut from spending.

Quite apart from the human grief this will cause in unpaid wages and bills, the effect on the wider economy would be utterly catastrophic. We are talking of an event of almost biblical proportions here. As the economy contracted, tax revenues would also plummet, and in little time at all the government would be chasing its tail down a downward spiral of cuts and falling tax revenues. At that point, default would become inevitable, however firmly the US might insist otherwise. The debt dynamics would be unsustainable.

It’s conceivable that the Federal Reserve could act to monetise the deficit by printing dollars to finance it, or simply cancel the government debt it already has on its balance sheet, but many would think that a default in all but name. These are nuclear options. The fallout would be extreme.

Once default is viewed as inevitable, the interbank lending market would freeze anew, prompting a second, global credit crunch on top of the violent contraction going on in the core of the US economy. It would be the 1930s all over again.

All this makes it pretty much unconscionable that a borrowing freeze will be allowed to happen. Somehow or other, a way will be found to raise the debt ceiling. It may not be by much, but it will buy a little time.

A sticking plaster solution is better than no solution at all, but it won’t address the US’s underlying fiscal problem and if the political stalemate continues in the meantime, we’ll only be back at the same point in six months to a year’s time. A credit downgrade already looks pretty much a done deal.

Uncertainty feeds economic stagnation, and so long as nothing is done to reach a lasting solution, decisions on whether to build that new factory, take on extra workers, or purchase the new automobile won’t get taken.

Dollar hegemony has been under threat for a long time now, but whatever the outcome of this latest political charade, it will come to be seen as a watershed moment when America finally lost the plot and condemned herself to lasting decline. Can a country that puts political bickering before the interests of economic and financial stability really be trusted with the world’s major reserve currency. I think not. The spell is broken. The age of the mighty dollar is over.

According to Winston Churchill, the US can in the end always be relied on to do the right thing, but only after all other possibilities have been exhausted. I wish we could be sure it was still true.

A US debt deal will be done, but it will offer only temporary respite.

After another humiliating defeat for John Boehner’s bill, where are we now in the hunt for a compromise to head off US default and government shutdown? No nearer a deal, that’s where. It’s a quarter to midnight and House Republicans cannot even agree among themselves on the way forward, let alone reach an accord with the Democrat Senate. If there’s still nothing over the weekend, then we can expect markets, already jumpy enough, to be showing real signs of distress when they open first thing Monday morning.

After the markets hace closed on Friday, the US Treasury is expected to announce details of what it intends to do in the event of failure to raise the debt ceiling. We have to assume it still plans to honour its debts above all other priorities. Even so, there’s talk of the Treasury preparing the ground for delayed payments. Whatever the contingency plans, the Treasury’s options are extremely limited.

There’s probably enough money left in the kitty to keep spending at current levels for a couple of weeks or so, but at some point it’s going to run out. When that happens, the Treasury will have no option but to move rapidly to bring spending into line with revenues. Almost overnight, an amount equivalent to some 8pc of GDP will have to be cut from spending.

Quite apart from the human grief this will cause in unpaid wages and bills, the effect on the wider economy would be utterly catastrophic. We are talking of an event of almost biblical proportions here. As the economy contracted, tax revenues would also plummet, and in little time at all the government would be chasing its tail down a downward spiral of cuts and falling tax revenues. At that point, default would become inevitable, however firmly the US might insist otherwise. The debt dyanamics would be unsustainable.

It’s conceivable that the Federal Reserve could act to monetise the deficit by printing dollars to finance it, or simply cancel the government debt it already has on its balance sheet, but many would think that a default in all but name. These are nuclear options. The fallout would be extreme.

Once default is viewed as inevitable, the interbank lending market would freeze anew, prompting a second, global credit crunch on top of the violent contraction going on in the core of the US economy. It would be the 1930s all over again.

All this makes it pretty much unconscionable that a borrowing freeze will be allowed to happen. Somehow or other, a way will be found to raise the debt ceiling. It may not be by much, but it will buy a little time.

A sticking plaster solution is better than no solution at all, but it won’t address the US’s underlying fiscal problem and if the political stalemate continues in the meantime, we’ll only be back at the same point in six months to a year’s time. A credit downgrade already looks pretty much a done deal.

Uncertainty feeds economic stagnation, and so long as nothing is done to reach a lasting solution, decisions on whether to build that new factory, take on extra workers, or purchase the new automobile won’t get taken.

Dollar hegemony has been under threat for a long time now, but whatever the outcome of this latest political charade, it will come to be seen as a watershed moment when America finally lost the plot and condemned herself to lasting decline. Can a country that puts political bickering before the interests of economic and financial stability really be trusted with the world’s major reserve currency. I think not. The spell is broken. The age of the mighty dollar is over.

According to Winston Churchill, the US can in the end always be relied on to do the right thing, but only after all other possibilities have been exhausted. I wish we could be sure it was still true.

An Inconvenient Precedent for the Debt Crisis

CATHERINE RAMPELL

Dollars to doughnuts.

Last night, President Obama and the House speaker, John Boehner, gave dueling speeches on how to fix the deficit. One line from Mr. Boehner’s speech confused me:

Dollars to doughnuts.

Here’s what we got for that spending binge: a massive health care bill that most Americans never asked for. A ‘stimulus’ bill that was more effective in producing material for late-night comedians than it was in producing jobs. And a national debt that has gotten so out of hand it has sparked a crisis without precedent in my lifetime or yours.

The wording is a little ambiguous, but it appears that the “crisis without precedent in my lifetime or yours” refers to the current stalemate over the debt ceiling and the resulting threat of default.

With all due respect to Mr. Boehner, there is a precedent for this, and it was in his lifetime.

Mr. Boehner was born in 1949. In 1979 there was a showdown over raising the debt ceiling, and the country came within hours (not days) of defaulting on its obligations. In fact it actually did temporarily default on some of its obligations, although that seems to have been because of technical difficulties because discussions ran so close to the wire.

Brady Dennis of The Washington Post wrote a nice summary of this event earlier this month:

Congress had been playing a game of chicken with the debt limit, raising it to $830 billion — compared with today’s $14.3 trillion — only after Treasury Secretary W. Michael Blumenthal warned that the country was hours away from the first default in its history.

That last-minute approval, combined with a flood of investor demand for Treasury bills and a series of technical glitches in processing the backlog of paperwork, resulted in thousands of late payments to holders of Treasury bills that were maturing that April and May.

“You hear a lot of people say, ‘The government never defaulted.’ The truth is, yeah, they did. … It might have been small, it might have been inadvertent, but it happened,” said Terry Zivney, a finance professor at Ball State University who co-authored a paper on the episode titled “The Day the United States Defaulted on Treasury Bills.”