Friday, July 29, 2011

US Debt Crisis of Concern to World

Recently, the debt crisis of the Euro Zone worsened and spread to Italy. However, this is no match for the growing possibility that the US Government may not be able to pay its national debt from 2 August onward.
US President Barack Obama has had a one-week-long negotiation with leaders of both the Democratic Party and Republican Party in a bid to avoid closing down parts of the federal government. The current debt ceiling set for the federal government of the United States is $14.29 trillion. This limit will be hit by 2 August. The US Congress has to approve raising this limit before this date. Otherwise, the government would have to put off some of its financial commitments.
Faster Depreciation of US Dollar
Ben Bernanke, chairman of the US Federal Reserve, warned that defaulting payment will trigger impacts to the global economy. More alarm was heard from two major credit rating agencies, Moody's and Standard & Poor's (S&P), which warned that if the political standoff persists, they will cut the United States' prized AAA credit rating.
There are a few reasons why the world, the developing world especially, should be on the alert under this situation. First of all, many developing countries hold a few billions of short-term US Treasury Bills as part of their foreign reserves. If happens, a debt default will have unpredictable impacts to countries that have no choice but to make a "haircut" or only have part of their Treasury Bills paid.
Defend Creditors' Interests
Although this seems quite unlikely, a debt default and downgrade of the credit rating alone will also devalue the US Treasury Bills. Moreover, the value of the US dollar seems to have depreciated faster lately. Thus, the losses may be bigger in the future.
Last week, China (which holds $1.15 trillion long-term US Treasury Bills) called on the United States to defend the interests of the holders of the US Treasury Bills through responsible policy and measures.
Secondly, if the impasse or the final solution plunges the United States into economic stagnancy or a new round of economic recession, the economic growth of developing countries will also be affected.
Substantial Cut in Government Spending
Regardless of the final deal of the US President and the two major parties, the core of the deal will certainly be a substantial cut in the government spending. This will cut down the effective demands of the economy. And this will contradict the effects of the monetary stimulus measures introduced by the Obama administration to address the economic recession. The stimulus package had successfully brought economic recovery to the United States in 2008 and 2009.
Thirdly, Washington stressed that there are uncertainties in the unhealthy dependence on the US dollar as the international foreign reserves. There is a need for reforms to reduce the dependence on one single currency. For example, some prominent economists like Joseph Stiglitz, Jose Antonio Ocampo, and Yilmaz Akyuz and some decision-makers like the governor of the central bank of China have advocated the Special Drawing Rights (SDR) (major currency basket) as a currency for global reserves.
Spur Reforms of Global Reserves System
Although a debt default of the United States is most unlikely, the matter has now turned from unimaginable to possible. This may once again trigger the discussions on the reforms of the global reserves system.
The facts of the current impasse facing Washington are as follows. The current $14.29 trillion debt ceiling will be reached by 2 August, therefore new borrowing is not allowed before this date. The government estimates that the debt ceiling has to be raised to $24 trillion, so that the government could fulfill its promises made for the period after the presidential election a nd before November 2012.
Many Republican congressmen, especially those influenced by the Boston Tea Party, hope that the government could achieve budget balance through substantial cut of spending without raising taxes.
But some Republican leaders are willing to consider small tax hike or even closing the tax loopholes. However, they find it hard to convince their colleagues in the party. They also hope the cut of spending could exceed the increase of the debt ceiling.
The President and Democratic Party are willing to cut down the spending substantially, but they also hope to raise the taxes on the rich, so that both can contribute to the reduction of the budget deficit. Leaders of the Democratic Party said unyieldingly that social and medical security must not be affected, although Obama is willing to allow some cut in this area.
Should the extreme attitude of the Boston Tea Party become the mainstream in the Republican Party, it will be a tough task to strike the deal. The Democratic Party and Republican Party must give in fully to solve this problem.
Should the impasse persists, a possible solution is the proposal made by the Senate Minority Leader, Mitch McConnell. During this period, the President proposed the plan to increase the debt ceiling and cut down budget, but the plan was rejected by the Congress and the President voted against it. McConnell's proposal will be passed, unless two-thirds of the Congress vote against it again.
Regulatory System Collapses
This has also made all quarters claim that they will hold on to their stands and avoid the crisis.
If no consensus is reached by 2 August, then the US Government would have no choice but to choose not to pay what items and when these items would not be paid. These include the interest of the short term national debt, social security, health care, vendors, unemployment relief, food, military expenditure, salaries for employees of the federal government, etc.
The priority will be paying debt. Thus it is very unlikely that the US Government would not pay the debt, unless the impasse persists for a long time. When there is no transaction, other services and remuneration will be affected and increase continuously.
Almost everyone would agree, there will be no way out for the government if it operates this way. Yet, the regulatory system of the United States is losing its functions. This has caused serious impacts to other countries. Therefore, everyone hopes that they could come out with a solution before 2 August.

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