Fears grew that the US could default on its debt next month due to political deadlock in Washington. Politicians continued to fight over conditions for approving a raise in the Treasury’s debt ceiling – the total amount of debt it can have outstanding – with several competing plans in circulation. Republican-backed ones prioritise more spending cuts while Democrats also argue for extra taxation.
What the commentators said
Both sides claim to be realists and tar their opponents as obstructive and partisan. But “the truth is, the Reid plan and the Boehner plan are not that different”, said Clive Crook on FT.com, referring to proposals from the Democrat leader of the Senate and the Republican leader of the House respectively. “Downpayment of spending cuts; process for further deficit reduction later” – both could be improved, but “either would raise the debt ceiling and avoid default, which after many wasted months is what matters most”.
Indeed, all the proposals are at best a stopgap, said Capital Economics. The outcome will be between $1trn and $2trn of savings over the next decade. If the Republicans defeat Democrat demands for $400bn in tax rises, the result will be closer to the former. “That sounds like a lot of money and, to be fair, it isn’t a bad start.” But under Congressional Budget Office projections, the cumulative deficit to 2020 will be more than $12trn – so clearly these plans will not put public finances back on a sustainable path. Yet “a more comprehensive solution… is probably out of the question until after next year’s election in November. Hopefully a clear victory for either parties’ candidate would bestow them with enough political capital to get a deal done.” Otherwise, ratings agencies might make good on the threat to downgrade the US government’s AAA credit rating.
But for now the biggest fear is not an eventual downgrade – it’s an outright default, if only for a while, as the government runs out of borrowing headroom. Markets think this is unlikely, said The Economist’s Buttonwood. A last-minute deal before the deadline of 2 August is probable. If this doesn’t happen, that date may not be a hard limit anyway – improving tax revenues suggest the US might be able to keep paying its bills until September. And since there is no priority on the order of payments, the government could put workers on temporary lay-offs or stop paying suppliers to avoid defaulting on its debt payments. “But what if all those options failed?” A default could do severe damage to the global financial system. “Given the fragility of the economic recovery, this is an incredible risk to contemplate.”