Will America default?
The US government shutdown is neither a new event nor usually a significant factor for the US market and economy. The main worry is the debt ceiling
Markets have expressed "mild concern rather than panic" over the stand-off in the US Congress, as the Buttonwood blog puts it on Economist.com.Stocks have edged down rather than slid sharply over the past fortnight."Given what is at stake, one would have expected a stronger reaction," says the FT.
As we noted last week, the US government shutdown is neither a new event nor usually a significant factor for the US market and economy. The main worry is the debt ceiling.
On 17 October the Treasury will have reached the legal borrowing limit imposed by Congress. If politicians do not raise the ceiling before this date, Washington would run out of money to pay all of its bills. Unable to borrow more, the Treasury would only be able to use the money coming in as tax revenue for its expenditure. It will therefore be unable to fund all government programmes and welfare spending, which will undermine growth as government-dependent companies' and people's incomes are hit.
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And among the bills it won't be able to pay will be interest on government debt, which would amount to a default. This would be unprecedented, so nobody knows exactly what would happen.But the danger is that "it might cause a financial heart attack like the one prompted by the collapse of Lehman Brothers" in 2008.
US Treasuries are widely used as collateral throughout the global financial system. They comprise over 30% of the collateral underpinning the tri-party repo market, a key source of overnight funding among banks.If investors no longer have unalloyed faith in risk-free US bonds and insist on more or different collateral, interest rates are likely to rise and turbulence would spread through various bond markets. The ramifications of a US default would be "both global and unpredictable".
America could theoretically balance the budget abruptly to avoid having to borrow and risk defaulting on its debts, but this would require savage spending cuts worth around 4% of GDP, and almost certainly implies a new recession. Nor is it clear whether the Treasury can legally prioritise some payments debt interest, for instance over others, notes Capital Economics.
Mid-November may be the crunch point, as a big interest payment is then due. Given how fast panic can spread we must hope, concludes the FT, that "sanity returns to Washingtonbefore investors make up their mind that it is not going to".
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