News coming out of the US is increasingly becoming a matter of concern not because it paints a gory picture of the state of economy, but also because, according to my personal concern, of its consistent use of deflection as a media strategy to score a few brownies here and there.
The world, especially the emerging markets, has not even recovered from the after-effects of Quantitative Easing (QE) tapering fiasco; we have the news of another storm brewing on possible 'US shutdown' casting a possible doomsday scenario on the world economy not too far in future. If the news does sell, we may witness another round of panic scramble on the economic canvas of the world.
To satiate the hunger of the curious lot, let's assume US shutdown does happen. It basically means that congress, which comprise of both Democrats and Republicans, does not pass the bill to raise the debt cliff beyond the prescribed limit of $16.94 trillion. It will mean that the government will not have resources to fund numerous 'politically sensitive' programs including Social Security, Medicare, retirement benefits for military and civil services workers, and interest payments on outstanding debt, beside numerous other government funded initiatives on domestic, military and foreign policies. In other words, US as a country will virtually come to a standstill, which will obviously have severe impact on the world economy.
To put the situation in perspective, notably, almost every government in the world runs a fiscal deficit operation. The gap between what it spends to what it earns is met by borrowing - a phenomenon most governments follow. Unlike India, where there is no limit to posting a deficit, US adopts a policy of debt ceiling to limit the deficit US government can post. Rightly so, the policy ensures that government operates within limit. If it needs to cross the limit, it must undergo the rigorous process of obtaining the nod of congress. Apparently, the Democrat government is facing challenges in getting the bill passed through a Republican majority congress. It indicates that that the issue is more political than economic.
The political logjam emanates from the confronting position of the two parties on whether to continue to run an economy loaded with debt. Since 2008 meltdown, US have been virtually printing debt by buying bonds. Federal Reserves, the central bank of US, has accumulated an estimated $2 trillion by printing dollar to finance the deficit since 2008. Republicans argue that upward revision of debt ceiling would feed into bond buying spree by the Fed. This is a problem because interest on these bonds and maturing bonds needs to be repaid, which would come in form of printing more money and selling more bonds, which will add to the burgeoning debt. US, obviously, is caught in the vicious cycle of raising more debt to finance its obligations.
Notwithstanding the structural flaw, shutdown will mean that US will default in its obligation. US bonds by far the safest asset on the planet and any default on its part is likely to trigger a chain reaction with unimaginable consequences both to the world as well as the US. This is an event no one in the world will want to let happen. It is the unimaginable quantum of risk following this event that makes the situation virtually risk free. This is the reason why even US markets have not reacted negatively. Moreover, this is not the first time US government is trying to raise the debt ceiling. Federal debt capping has been since 1939 and Congress has raised it numerous times. Similar debt ceiling showdown was witnessed in August 2011, which was eventually resolved at the last minute. Somewhere there is a confidence that the logjam will be resolved soon, like many times in the past. Till then, it is politics as usual.
Events in US send nervous tremors across the world but the state of its highly leveraged economy keeps raising its ugly head every now and then. Countries, such as China, will be very nervous today. Even if US are able to avert the political crisis this time, it should serve as a reminder to rest of the world of highly volatile times ahead. US do not have much choice but to play its debt cards right. Its fortune is aligned to misfortunes of other economies that are dependent on dollar. Otherwise, in an ideal world, US currency should face sharp depreciation, just like India and other emerging markets faced recently.
(The writer is Director, InvestCare, leading wealth advisors. You can reach him atsamar.vijay@investcare.in)