US debt fears: how worried should we be?

President Barack Obama is locked in talks with Congress to increase the amount of money the US can borrow to plug the gap between what it spends and raises in taxes.

The president is pushing to increase the current $16.7tr limit, which will be reached by the end of Wednesday.

The US Treasury has warned that if a deal is not reached, there could be a financial crisis and recession on the same scale as 2008, when the credit crunch laid waste to the economies of America, Britain and other industrialised countries.

Default

In theory, if Congress does not approve an increase in the debt ceiling, the US could find it impossible to repay its debts, leading to a default.

The US borrows money by issuing bonds known as Treasuries – IOUs that have to be repaid, with interest, on a specific date.

If it cannot honour these IOUs, confidence in the US financial system is likely to fall, with adverse consequences for other parts of the world as stock markets fall and interest rates rise.

Thursday will not be D-Day (default day) … even if a deal isn’t done to raise the debt ceiling, we don’t expect the sky to fall in on Thursday. Paul Dales, Capital Economics

Commodities trader Jonathan Sudaria, from Capital Spreads in London, writes in a client note: “Today is definitely not the day to be conducting any serious business as traders across the globe will be hypnotised by their TVs/terminals and anxiously waiting for something to hit the news wires.”

The credit rating agency S&P downgraded the US in 2011 and Fitch has now warned that its AAA rating is also under threat because of the impasse. This could lead to higher borrowing costs for the US, which would have implications for other nations.

Worrying

This all sounds deeply worrying if you live in a country (Britain) that was hit particularly hard by the 2008 banking crisis and is only now, five years later, growing at a rate that should lead to greater prosperity in the years to come.

But there is no need to panic yet. The markets remain relatively calm, in expectation that a deal will be done on Capitol Hill.

HSBC’s Daragh Maher says the markets “seem pretty hopeful that we will have this compromise deal … I am as hopeful as anyone, but we will have to wait and see, and that is exactly what the market is doing, waiting and seeing”.

The end of Wednesday has been painted in some quarters as the moment of truth, when the US finds itself in default mode if a deal is not done.

But this is not the case. Analysts at HSBC say that even if the US does end up delaying interest payments on some of its Treasuries, this would not be the same as a large-scale bond default.

They make the point that a limited default would be a result of “political dysfunction in Washington”, rather than an economic or financial crisis.

And they say the widely-held assumption is that the US will re-pay its debts, but could be late in doing so.

Not D-Day

Capital Economics is also relatively sanguine, with senior US economist Paul Dales arguing in a briefing note: “Thursday will not be D-Day (default day) … even if a deal isn’t done to raise the debt ceiling, we don’t expect the sky to fall in on Thursday.”

Mr Dales says the US Treasury takes about $10.8bn a day in taxes and spends roughly $13.3bn.

It borrows to meet this shortfall by issuing Treasuries, but if money from investors is no longer available, the government can still fall back on $36.5bn of cash reserves and “should be able to meet all its obligations for another two weeks”.

Mr Dales has taken a detailed look at the US Treasury’s spending schedule, and says that tax revenues and reserves should be enough to cover the $12bn of social security payments due on 23 October and the $3bn of federal salaries due two days later.

“But they may not cover the $6bn of debt interest payments due on 31 October and almost certainly won’t cover the $57bn of social security, Medicare, military and income support payments due on 1 November. And there’s no chance whatsoever of meeting the $30bn of debt payments due on 15 November.”

So while Thursday is not “D-Day” for America or the world, Congress has to take decisive action this month if it wants to avoid a situation it may not be able to control.