Stephen Foley: The time for America to to get her finances back in order is running out
Saturday 21 May 2011
US Outlook: Take a look around, said the Fox News presenter, sarcastically, over a live webcam of Times Square in New York. "Life as we know it is merrily going on in the United States of America."
Ha-di-ha. When the US hit its debt ceiling on Monday, the $14.3 trillion limit set by Congress for the amount the federal government can legally borrow, the world obviously did not end. Fox got another chance to mock warnings of economic catastrophe and financial Armageddon that have come from the Obama administration.
The US is the only system stupid enough to require a second law raising borrowing limits when its legislature passes a budget that implies an increased deficit. So here we are, and now the country is running on borrowed time.
This week, the Treasury stopped issuing new debt to fund public pensions, and with a few more accounting tricks, it oughtn't need to borrow any more for a while to fund its expenditures. After that point (Treasury Secretary Tim Geithner says it comes in August) the choices get a lot harder.
Eventually, the Treasury would have to choose between paying benefits such as social security, paying federal workers, and paying the interest on its debts.
Republicans, and Tea Party representatives in particular, think this is all rather joyful, since it provides a second opportunity to squeeze government down in size, after they didn't get the cuts they wanted from the budget deal in the spring. The consensus is that there will be a political deal that raises the debt ceiling and introduces a new wave of federal budget cuts at the same time.
That is why the yield on US government debt has gone down, not up. Markets believe the outcome of this impasse will be a big fiscal contraction, with a resulting hit to the pace of the US economic recovery that forces the Federal Reserve to keep interest rates on hold at zero for longer.
I would be worried, though, by the increasing boldness of the cut-and-be-damned brigade. The consensus had previously been that a deal would have been reached before the US hit the debt ceiling. That has not come to pass. Each passing day emboldens those holding out for more reductions to spending.
The trouble is that it is not clear when a crunch moment will come. The budget deal in April was agreed with an hour to spare before the federal government would have been forced to shut down its non-essential functions.
Ultimately, the timing and the nature of the crunch moment is up to the Obama administration to engineer. It has to decide what unpleasant medicine to threaten. Will the Treasury set a date that it will stop paying soldiers? Or warn pensioners that their last social security cheque will be posted in August? Or will it threaten US bondholders with default?
The last is quite tempting. It would certainly be a comeuppance for Fox News, and for the entire habit of mind that refuses to believe in the possibility of financial Armageddon, despite the evidence of 2008. At the moment Wall Street is so discredited that no one believes Jamie Dimon when he says (as he did this week) that a US debt default will "dwarf Lehman" in its consequences, and the complexities of the markets make it hard to explain what might happen.
But US government debt is essential to every part of the financial system. It is the collateral in trillions of dollars of interconnected lending transactions. It is the lynchpin of numerous low-risk investment funds, including the money market funds that millions of Americans treat like bank accounts. A default on a US Treasury bond would rip up the underfabric of the financial markets. The only thing certain about the resulting uncertainty, is that it would lead to a panic.
So the Treasury cannot be so irresponsible as to threaten default. Even the suggestion that it has moved out of the "unthinkable" category, to "thinkable", would force a massive and destabilising change of behaviour on Wall Street.
Which is why its hand is weak, and why the Tea Partiers are on the march. More cuts are coming to the US, and a weaker economic recovery. Interest rates, far from going sky high because of default worries, may well go lower and stay low.
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