Saturday, July 30, 2011

Democrat threats of default much exaggerated

Jul 30, 2011
U.S debt crisis
By Caroline Baum

I'M SITTING at my computer, watching the national debt clock tick relentlessly higher, as if to challenge me to make mental computations. How long does it take the United States to accumulate an additional US$1,000 (S$1,210) in debt? Answer: Faster than my eyes can move from the screen to the second hand of my watch. At that pace, how long would it take to add US$1 billion? US$1 trillion? Too many zeroes for my brain.

This is just a distraction - for me and for Washington politicians. We're both trying to avoid getting down to work.

For Washington's part, the short-term focus on raising the US$14.3 trillion debt limit by the Treasury's Aug 2 deadline has become a diversion from the nation's long-term fiscal problems. The federal government has to rein in the growth of its debt so that it becomes manageable in relation to the size of the economy.

You wouldn't know it from listening to the lecturer-in-chief on Monday night. In his address to the nation, President Barack Obama resorted to many of his favourite divide-and-conquer techniques, more suited to warfare than politics, in an attempt to demonstrate he is rising above the fray.

He blamed Mr George W. Bush, this time for squandering the budget surplus the former president inherited. He played the class warfare card, setting up a choice between corporate jet owners and senior citizens, between hedge fund managers and their secretaries. He compared himself to Ronald Reagan, a comparison that challenges even the wildest imagination. And he scared the public and investors with the threat of default, even as he insisted on a debt-limit extension through the 2012 election to spare the economy further damage.

All this while invoking the spirit of compromise and the need to 'come together as one nation'. Mr Obama's Washington-knows-best attitude was on display on Monday night when he said most Americans outside of Washington had probably never heard the term 'debt ceiling' before.

The only way Americans could possibly be unfamiliar with the term is if they had tuned out the President for the last few weeks. The President and his Treasury Secretary, Mr Tim Geithner, have taken every opportunity to fan the default flames, even though such an outcome is highly unlikely.

Default is defined as the failure to make timely payment of principal and interest. Standard and Poor's (S&P) uses that definition, specifically as it pertains to market debt, when it issues its sovereign debt ratings.

The Treasury is not going to default next month, or in subsequent months for that matter. An estimated US$172.4 billion of tax revenue next month is more than enough to cover the US$29 billion of August interest payments. For fiscal 2011, which ends on Sept 30, the Treasury is expected to take in revenue of US$2.2 trillion, while only US$214 billion is needed to service the debt.

And even if it lacks the authority for new borrowing, the Treasury can continue to roll over existing debt.

Instead of dangling the default threat every chance they get, Mr Obama and Mr Geithner should be telling the world that the US has every intention, and the resources, to meet its debt obligations. They should shout it from the rooftops, put a banner on the Treasury Direct website, and use the Sunday talk shows to reassure investors, not frighten them.

The administration's stated desire to remove the uncertainty hanging over the economy flies in the face of their sabre- rattling. Why, one might even conclude that they are - perish the thought - playing politics with the debt ceiling! (Oh, wait, it's the Republicans who are doing that.)

Until this week, financial markets were taking Washington's fiscal follies in stride. Surely these folks won't prevent the government from making good on the spending decisions of prior Congresses.

In the past two days, the discount rate on Treasury bills maturing on Aug 4 has gone from 0.05 per cent to 0.15 per cent. This week's five- and seven-year note auctions met with tepid demand. The price of a one-year credit default swap on the US, a derivative contract that offers default protection, rose to a record 80 basis points from 46 basis points last week.

Just because the US isn't going to default doesn't mean it can pay all its obligations, including social security and veterans' benefits, payments to defence contractors and money distributed to the states. The federal government borrows about 40 cents of every dollar it spends, so it would have to prioritise its payments if Congress fails to raise the debt ceiling by next week.

A failure to pay its bills may be cruel and unusual punishment for seniors who rely on their monthly cheques; it may hurt an already weak economy; it may cause chaos and disruptions in financial markets; and it may leave a scar on a great nation. But it does not qualify as a default.

That said, an increase in the debt ceiling is no guarantee the US will retain its AAA rating. When S&P put the US' top rating on CreditWatch on July 14, indicating a 50 per cent chance of a downgrade in the next 90 days, it made clear that its decision would be contingent on both a debt-limit increase and a 'credible solution to the rising US government debt burden'.

One way or another, Congress will raise the debt ceiling by Aug 2. I wish I had the same confidence watching the Washington play-by-play that S&P's second criterion will be satisfied.

The writer, a Bloomberg View columnist, has been writing on the economy and bond market since 1987.


[An alternative view. I don't know how correct she is, but say she is and technically she is correct, but realistically, and perhaps perceptually, she is wrong. In any case, it would seem that the treasury ran out of new borrowings earlier in the year and prioritising payments is what the US Treasury has been doing.]

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