Wednesday, October 16, 2013

The U.S debt ceiling and Canada

There’s lots of talk south of the border as the deadline to raise the debt ceiling looms. Many Canadians are scratching their heads wondering what the heck it all means and should it matter to us. It’s a good question but the answer is complicated. 

Raising the debt ceiling allows the U.S Treasury to borrow more money to fund the business of government. Right now the government is in a partial shutdown, meaning many programs including social programs have stopped operating and workers have been sent home.  Not raising the debt ceiling means the U.S. Treasury will run out of money and won’t be able to cover its bills. If that happened, it would be a historical first.

No one really knows what would happen next. Some liken it to the Lehman Brothers collapse in 2008 that sent the U.S. economy into a recession, with global consequences, only this time it would be far worse.

 “A default would be unprecedented and has the potential to be catastrophic,” a U.S. Treasury report said. “Credit markets could freeze, the value of the dollar could plummet, US interest rates could skyrocket, the negative spillovers could reverberate around the world, and there might be a financial crisis and recession that could echo the events of 2008 or worse.”

That’s not good.

The U.S. debt limit came into effect in 1917 to help Congress pay for World War One. It has been raised periodically to cover any shortfalls in government spending. In 2011, the Tea Party Republicans refused to approve raising the debt ceiling unless certain spending cuts were made – this time the impasse is about Obamacare.

Financial experts suggest that if the debt ceiling is not raised and the U.S. government defaults, the first thing that might happen is that investors will lose confidence and stock markets will fall, not only in the U.S., but globally as well. Borrowing costs will increase and economies will slow down. But those same experts agree that U.S. Congress will likely stop bickering and make concessions to avoid default. 

Last week, President Obama held a press conference sending a message to Congress on how ridiculous it was to keep their “no deal” stance. U.S. business and U.S. markets have sent loud and clear messages to Congress to not push the country to the brink of default. The Republican Party is now viewed favourably by only 28% of Americans, down from 38% in September. This is the lowest favourable rating measured for either party since Gallup began asking this question in 1992.

A  Globe and Mail article on October 16, 2013, questioned if even having a debt ceiling was a good idea. A University of Chicago January survey of U.S. economists found that a majority strongly agree that “a separate debt ceiling that has to be increased periodically creates unneeded uncertainty and can potentially lead to worse financial outcomes.” 

The reason economists don’t like it is because of how much it sets back economic growth worldwide.  Central Banks around the world are already making contingency plans.

Tomorrow, October 17 is deadline day. When one country is a powerhouse for global economic growth and is vulnerable to the whims of one small sector of its constituency, then perhaps the economic model needs to changed.