‘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 firstname.lastname@example.orgThe 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 who doesn’t.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 hitherto.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.