The default (that never was) has only got deferred

Continuation of my earlier post:

While this shutdown was dramatic (possibly emotive) it was the specter of US Default that prompted Xinhua, the Chinese news agency, to call for ‘de-Americanisation’ of the world.

And, I am now talking about the debt-ceiling law of US. Quite simply, there is a cap on the maximum debt the US federal government can carry. The genesis of such a cap goes back to early 20th century era, when the US elected representative thought it a good idea to rein in the US President’s power in terms of issuing debt (or borrowing).

After numerous changes, the last limit, despite certain extensions since May, was to have expired last Thursday – was $ 16.7 trillion.

But why does the US want to borrow? Quite simply it borrows to fund its expenses (defense, social investment & welfare, governance, infrastructure, space exploration, etc.) which is more than its income (primarily from taxes).

And how does the US borrow these ‘loans’? Rather easily. It issues US Bonds to the world investors. And the world flocks in. And the primary reason the world invests in US bonds is the relative safety of America (societal, political, institutional and legal) combined with the comparative wealthier economy. Relative and comparative to most other nations / associations (like EU) around the world.

US Debt Default:

If borrowing was for new stuff, this limit would not be a problem. But a big reason for borrowing is to service existing debt – and this is where the theoretical and ideological idea of imposing a limit crashes into real life requirements.

Now, if the US can’t borrow more, it has two choices:

  • Today, if the US wants to service its existing debt (which it is obliged to), it needs to start spending less on many other stuff – all those good stuff which make the American economy & society what the world favors (even though we may not openly say so)
  • Alternatively, it needs to default on its debt but continue to spend on all other stuff

So, it was with some relief that the US lawmakers agreed to continue to borrow till early 2014 and thereby defer this issue of debt limits for few months.

So what?

Well, as a non-American, there should be little worry (despite Mr Obama saying so) that investments in US sovereign debt will not be met. While possible, it is highly unlikely that US law-makers will follow the default route. So default on debt will not happen.

However, if the ability of US federal Government to borrow more to fund growth (economic or societal) ceases, the power of US economy (as manifested by its currency) could start weakening (on a relative term) and investors will seek higher expected returns to offset any such possible erosion of dollar value.

Alternatively, investors will shift their investments from Dollars into something which is, as Xinhua implied, de-Americanised – and this could merely mean continue investing in US but without the current process of a debt-ceiling discussions and ratification by politicians.

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This entry was published on October 19, 2013 at 11:50 am. It’s filed under Economics, Politics, US and tagged , , , , , , , , . Bookmark the permalink. Follow any comments here with the RSS feed for this post.

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