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A meeting at the White House this week could avert what\u2019s shaping as a financial and economic crisis with global dimensions.<\/p>\n
Joe Biden will meet congressional House leader Kevin McCarthy and other Republicans on Tuesday to try to negotiate a path away from a breach of the US Government\u2019s borrowing limits, the $US31.4 trillion ($46.6 trillion) \u201cdebt ceiling\u201d that could be breached as early as June 1.<\/p>\n
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The Democrats and Republicans are at loggerheads over raising the US debt ceiling. <\/span>Credit: <\/span>AP<\/cite><\/p>\n With Biden adamant that the debt ceiling should be raised via a standalone bill but the Republicans, who control a majority of the House, equally adamant that they\u2019ll only raise the ceiling if Biden agrees to swingeing cuts to government spending \u2013 spending Congress has previously approved \u2013 financial market participants are taking the prospect of an historic US government default on its debt increasingly seriously.<\/p>\n Last week the US Treasury sold $US50 billion of 30-day bills, maturing on June 6 \u2013 or around the potential earliest date for a default \u2013 at a record yield of 5.84 per cent. Only a week earlier an issue with a similar duration, maturing on May 30 (and therefore ahead of the earliest \u201cX date\u201d) sold at a yield of only 3.83 per cent.<\/p>\n The difference in yields in those two issues essentially monetises the fears of investors in higher interest costs for the US government.<\/p>\n Since the middle of last month the yields on three and on-month hills maturing around early June have increased by about a percentage point while the cost of insuring against a default (via credit default swaps) has risen to record levels.<\/p>\n On Sunday, US Treasury Secretary, Janet Yellen, said it was Congress\u2019s job to avoid a default.<\/p>\n \u201cIf they fail to do it, we will have an economic and financial catastrophe that will be of our own making and there is no action that President Biden and US Treasury can take to prevent that catastrophe,\u201d she said.<\/p>\n Last week the White House released a paper outlining the potential effects of the various debt ceiling scenarios, ranging from brinkmanship that averts a default at the eleventh hour, to a short-lived default to a protracted one.<\/p>\n In the least-worst scenario, 200,000 jobs would be lost, real economic growth would be trimmed by 0.3 per cent and unemployment would rise by 0.1 per cent.<\/p>\n There have been dire predictions released over what would happen to global markets if the US went into default. <\/span>Credit: <\/span>AP<\/cite><\/p>\n If the outcome were a \u201cshort default\u201d half a million jobs would go, real GDP would be cut by 0.6 per cent and unemployment would rise by 0.3 per cent.<\/p>\n In the event of a protracted default, the cost would be 8.6 million jobs, a 6.1 per cent fall in real GDP and a 5 per cer cent increase in unemployment.<\/p>\n Any default would limit the government\u2019s ability to act to blunt the economic effects because it would be unable to borrow. The economic downturn would also likely impact the ability of households and businesses to borrow and, in any event, interest rates would \u201cskyrocket\u201d for the government, businesses and households.<\/p>\n The White House paper cites an analysis by credit ratings agency Moody\u2019s that even with a brief default interest rates would spike, equity prices would plunge and short-term funding markets would probably shut down.<\/p>\n It also referred to a Brookings Institute paper that said the damage to the perceived safety and the liquidity of the US bond market could translate to more than $US750 billion of increased federal government borrowing costs over the next decade.<\/p>\n A simulation run by the administration\u2019s own Council of Economic Advisers (CEA) concluded that a protracted default would generate an immediate, sharp recession of the order of what the Americans call \u201cthe Great Recession,\u201d or the economic downturn the US experienced between December 2007 and mid-2009 in the midst of the global financial crisis.<\/p>\n During that period GDP fell about 4.3 per cent, the unemployment rate reached 10 per cent and US household net wealth fell by more than 17 per cent. It wasn\u2019t until 2016 that the jobs lost during the Great Recession were fully recovered.<\/p>\n The CEA simulation also showed the US stockmarket \u2013 a market that influences most international equity markets \u2013 plummeting 45 per cent.<\/p>\n Treasury Secretary Janet Yellen has put pressure on Congress to make a deal.<\/span>Credit: <\/span>AP<\/cite><\/p>\n US financial markets, and the US bond market in particular, influence global financial activity. Most financial assets are ultimately benchmarked against the \u201crisk-free\u201d US 10-year bond rate and the US market has, in the post-war period, been the world\u2019s financial safe haven.<\/p>\n If faith in US Treasuries were shaken, or indeed lost, it would reverberate through global financial markets, likely causing chaos and loss.<\/p>\n The US dollar\u2019s status as the world\u2019s reserve currency, which China, Russia and others are already doing their utmost to erode, would also be threatened if the US government were unable to pay its bills.<\/p>\n Merely flirting with the prospect of a default is damaging to the credibility of the US bond market and the dollar and is encouraging flows out of the market and the dollar to assets regarded as less risky.<\/p>\n The White House paper cites an analysis by credit ratings agency Moody\u2019s that even with a brief default interest rates would spike, equity prices would plunge and short-term funding markets would probably shut down.<\/p>\n The gold price, for instance, is at near-record levels. The dollar has been sliding in recent weeks and is down more than four per cent, on a trade-weighted basis, from its March peak (although the US regional banking crisis might also be a factor in that decline).<\/p>\n Previous episodes of brinkmanship over the debt ceiling have always been resolved without a default, albeit not without some concessions from the incumbent president and some collateral damage. In 2011, for instance, the US AAA credit rating was downgraded by Standard & Poor\u2019s. Another downgrade would by itself raise the cost of debt for all US borrowers.<\/p>\n There are some obscure pathways to an avoidance of the breach, although anything less than congressional authority would be controversial and embroil the administration in a constitutional crisis.<\/p>\n The hope is that Biden is able to convince the Republicans to separate the debt ceiling issue from negotiations over future \u2013 not previous \u2013 government spending, committing to reduce government spending materially in the budget for the 2023-24 fiscal year that starts on October 1.<\/p>\n It should be noted that the biggest increase in the levels of US Government debt that the Republicans are trying to use as a lever to force Biden to slash previously approved spending occurred during the Trump administration, a Republican administration. The Democrats approved increases in the ceiling during the Trump presidency, when government debt rose by $US7.8 trillion, or nearly 25 per cent of total national debt.<\/p>\n Neither Biden nor his party are prepared to accept the Republicans\u2019 demand for savage cuts to his program and McCarthy owes his position as speaker to the alliance of fiscal hardliners and MAGA fanatics which is determined to force Biden to succumb.<\/p>\n For some of those in that alliance it appears that humiliating Biden and the Democrats and being seen to have unravelled their \u201cwoke\u201d agenda \u2013 is more important than the damage a default would do to the economy.<\/p>\n That is why there are those within financial markets and the political sphere who fear that this time might be different \u2013 that the current confrontation involves something more than brinkmanship and therefore the dreaded prospect of a default is more realistic and threatening than it has ever been.<\/p>\n The Market Recap newsletter is a wrap of the day\u2019s trading. <\/i><\/b>Get it each we<\/i><\/b>e<\/i><\/b>kday afternoon<\/i><\/b>.<\/i><\/b><\/p>\n<\/p>\n
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