Thai authorities 'confident', but could a US default actually happen?

“Irrational ignorance” may be the right words to explain the dogfight between President Barack Obama and the Republicans over the fiscal bill, which has led to the partial government shutdown.

As the US will hit its debt ceiling in the middle of this month with no solution in sight, it is raising fears of a debt default. This development is confusing the rest of world as to how the US, the world’s largest economy, which is supposed to be best economy and political system, got stuck in this mess. The US and Thailand are among the 16 countries that have never defaulted on sovereign debt. If the US fails to service its liabilities, it will be unprecedented. 

Not just ordinary people, but also global institutions like the International Monetary Fund are frustrated about the US system. Christine Lagarde, head of the IMF, warned last week that if the US could not agree to raise the debt ceiling, it would be a far worse threat to the global economy than the current shutdown.

In the US, Nobel laureate in economics Paul Krugman described the situation in his blog as “hapless and hopeless”. He also severely criticised the Republicans as cynical, dishonest and very stupid.

The market is now closely monitoring signals from the White House and Congress about the possibility of solutions to the shutdown and debt ceiling. The Democrats and Republicans are still firm in their stances, as the Democrats want a clean budget bill but their rivals want to de-fund or delay the government healthcare scheme, known as Obamacare. Some critics say it is just political manoeuvring on both sides but some say it is akin to a caste war between the rich and poor.

The government shutdown and debt ceiling impasse have suggested that American society is experiencing a deep divide, down to its fundamental values. US media report that about a third of the Republican majority of 232 in the House of Representative are fellows of the Tea Party political movement, which is considered farther right than ordinary Republicans. 

The Republicans and the Tea Party are labelled as conservatives. They find government intervention in the economy distasteful and want less taxation and less government subsidies for social welfare. In contrast, the Democrats are liberals and promoters of the government’s role in the economy, using government spending to boost the economy and help low-income groups.

The argument of the conservatives or the right is simple and common sense – that the government has to cut spending in order to reduce the ballooning public debt, which will rise to the debt ceiling of U$16.7 trillion (Bt522.6 trillion) on October 17. They, the right, mainly like a market-based approach to healthcare schemes, letting individuals buy protection from private insurers. On the left, the Democrats believe that the government’s role is justified in boosting the economy during hard times and subsidising healthcare for moderate- and low-income families. 

Prominent American economists like Joseph Stiglitz, another Nobel laureate in economics, and Krugman side with the Democrat line – that the government has to stimulate the economy in times of recession or slow growth by increasing spending.

Many economists point to debt deleveraging’s impact on the whole economy. A large part of the population was forced to reduce their debts at the same time in the aftermath of the financial crisis of 2007-08. The process created a monster paradox of debt reduction with a rise in debt burden. As the process went on, firms cut jobs, cut investment or put off expansion because they could not sell their products, as consumers cut their spending. 

Then people would earn less income, many lost jobs, a lot faced house foreclosures. This chain of events made debtors less able to service their debts, so debts actually rose as interest rate costs multiplied. If let go in the hope that the market mechanism would somehow cure itself, the economy would go into a free fall and repeat the Great Depression of the 1930s in the US.

To arrest the downward spiral, economists have advocated more government spending to cushion the economy from severe contraction. After the 2008 global financial crisis, many governments including the Chinese and US did increase their spending. 

But US economists, in particular the believers in the dynamics of debt deleveraging, argue that Obama spent too little and cut spending too early. Obama had to concede to the Republican demand for a spending cut when he negotiated the lifting of the debt ceiling back in 2011. This time Obama insists on not caving in, leading to the current stand-off. 

Somehow, the dynamics of debt deleveraging or the paradox of debt reduction is counter-intuitive or counter to moral values. This makes US politicians, especially the Republicans and their supporters, unclear about how the economy works.

Judging from the economists’ point of view, the Republicans are ignorant about the science of economics and they oppose what is good for their own country. Economists, particularly the Keynesian school, are pressing the case forcefully that the economy’s recovery is still fragile and more government spending is needed to ensure it becomes full-fledged. And since government spending is reduced, the Federal Reserve carries on with its unconventional measure of purchasing long-term bonds in what is known as QE, in order to drive the economy, and partly to substitute for the fiscal role, which is facing constraints. 

Markets around the world are optimistic that the US will not fall behind on its obligations. The Bank of Thailand, which holds mountains of US government bonds, also maintains a belief along the same lines.

The “irrational ignorance” of US politicians, however, may prove the market and the Thai central bank wrong and then unprecedented damage may be inflicted on the global and local economies.