Debt default: Will the US avert a real disaster amid a stand-off in Congress?

US President Barack Obama is not keen to negotiate on his healthcare plan, and the House Speaker, John Boehner, pulled the budget bill from the floor. 

I watched the news and read a lot of articles on this issue and most market experts voiced concern about the deadlock. The partial government shutdown will not affect the world economy directly, but it will be affected indirectly by the US economic slowdown. The real disaster would be if the US government could not borrow more to pay off its obligations, which is expected to be necessary around the middle of this month. 

Obama said he would not negotiate unless Congress passed the budget bill and raised the debt ceiling, while Boehner said the situation “is not a game” after administration officials were reported to have claimed to be “winning” the stand-off. 

I am quite surprised that they are fighting in the media to gain public support instead of sitting down and talking. 

Meanwhile, many experts and heads of economic organisations, such as International Monetary Fund managing director Christine Lagarde, expressed concern over whether the United States would default on its debt. The negative impact would be hard to imagine, since foreign investors hold a lot of US government bonds. I recall we came across this situation at the end of last year when we were concerned about the US debt ceiling and the so-called fiscal cliff. In that situation, the US government needed to reduce spending and increase taxes to lower the budget deficit. They increased the debt ceiling on New Year’s Eve and the market was spared having to see what the fiscal cliff really looked like. Almost a year later, we are back to the same situation.

When I was a novice economist, I could not understand why we called for and allowed the world’s biggest debtor to take on more debt. I could not imagine, either, that the financial market would cheer with joy at the simple prospect of the US meeting its debt obligations to investors around the world. 

As a responsible person and a banker, I think the problem is overspending. If the Americans need to increase the debt ceiling, it means the US has more expenditure than revenues. In the short term, the new debt ceiling would help avoid global financial disaster, at least for now. However, I believe the market will eventually put a cap on US borrowing. 

I think back to the US Federal Reserve’s decision last month to delay tapering of its quantitative easing programme and continue with the policy of near-zero interest rates. The aim was to help the US government pay less interest on the huge pile of debt, not to help the economy or ensure the health of financial markets.

If US lawmakers raise the debt ceiling, which I believe they will, it means the US will borrow more and more. The interest rate in the long term will rise as creditors will demand more yield. The US will fail to pay its debt one day if there is no concrete action on spending. 

I remember learning when I was a junior banker that if you are a small debtor, the bank will come after you if you fail to pay. On the contrary, if you can borrow a lot, you are too big to fail and have more bargaining power. 

 

The opinion expressed belongs to the author, Padej Piroonsit of CIMB Thai Bank Plc.