shekel versus dollar 521.
(photo credit: REUTERS)
‘Exclusive: Obama team prepares plan for US default.”
This was a Reuters news headline on Thursday, as the deadline date of August 2 drew steadily nearer. Why August 2 is a deadline is a rather complicated story, but for the purposes of understanding American politics and world financial markets over the next few weeks, you have to regard that as an immutable fact. If, by that date, Congress does not vote to raise the ceiling on the amount of debt the US government is allowed to borrow, then the United States will be in default.
The foregoing sentence requires explanation. First, for reasons that are perhaps known to them but must also be accepted as a fact of life, the Americans have a system whereby the amount of debt that “Uncle Sam” is allowed to borrow is limited by law. In addition to Congress giving legislative approval to the annual budget, which almost always contains a deficit and therefore involves borrowing to cover the gap between revenues and expenditures, the legislature has to authorize the total amount of debt the nation is allowed to assume. Historically, this has not been a problem, and the debt ceiling has been raised whenever necessary (and with increasing regularity), under presidents and administrations of every stripe.
Now, however, the Republican-controlled Congress is balking at raising the debt ceiling further. This is because the budget deficit is huge – in excess of $1.5 trillion this year and almost as much last year – and the Republicans are vehemently demanding that this runaway deficit be brought under control. They have taken the debt ceiling as hostage and announced that they will not vote in favor of raising it unless Obama and the Congressional Democrats agree to a deficit-reduction package.
Furthermore, the Republicans insist that the said reduction stem from
spending cuts, with little or no tax increases, while the Democrats
demand that tax rises (primarily on the higher- income groups) be the
main weapon and are loath to make any cuts in entitlement spending
(Medicare, Medicaid and other programs).
This standoff has dragged on for months; indeed, it has intensified as
both sides harden their positions and become less amenable to
compromises. If no agreement is reached by D-Day, August 2, then the
ongoing borrowing of the US Treasury will be forced to a halt, and it
will have to live from its tax revenues alone. (As a matter of fact, the
Treasury hit the ceiling in May and, since then, has been “borrowing”
from government pension funds, to the tune of a cumulative $115 billion –
but don’t tell that to anyone on a government pension.) Since US tax
revenues are woefully inadequate to meet ongoing expenditures, not to
mention interest payments and redemption of maturing debt, the US
government will then have to decide its priorities: who gets paid and
But if it misses an interest payment, let alone a maturity payment, it
will be considered in default on its debts and will be downgraded
instantly by the ratings agencies, from its current pristine (and
make-believe) AAA rating, to D – for Default and implicitly, financial
Damnation. That, presumably, is what the Obama team is working on, and
it doesn’t need an exclusive story to know that this is happening in
some backroom in Washington.
Of course, it should never come to this, or anywhere near this. But the
obtuseness of the American political system and the people in it is now
so great that no one can continue to blithely assume that political
common sense will prevail.
True, everyone expects a last-minute compromise that will raise the debt
ceiling sufficiently to at least cover the next few months of borrowing
– and preferably by enough to see the US through the end of 2012 and
the upcoming presidential election. But lack of confidence in the
politicians is now so intense that no one can be sure that one or the
other side will not overplay its hand.
There are also those who believe that the brinkmanship will deliberately
extend beyond the deadline, to force a technical default for at least a
brief period and thereby trigger a panic in the markets. This shock
treatment, they believe, is essential to force the politicians to “get
serious” about the budget deficit and begin taking meaningful steps to
reduce it, rather than tinkering around the edges as they have done
In the good old days of the Cold War, the dominant military doctrine was
MAD: mutually assured destruction. This meant that both sides had
enough nuclear missiles to survive a first strike by the other and
launch a sufficiently powerful counterstrike that would wipe out the
enemy, so that neither side could win in any scenario. Consequently,
neither side had an incentive to attack, while both had a strong
incentive to do nothing.
In Washington today, a few more weeks of mutual neutralization will
assure the destruction of the credibility of the US and, by extension,
of the dollar and the American financial system. Most likely, this
disaster will be blamed on both parties and will assuredly result in the
destruction of the political careers of the leaders responsible. That
consideration, if no other, should serve to push them to cut a deal that
will, at the least, buy time and defer both dealing with the deficit
and default until 2013.[email protected]