Markets price a U.S. Government debt default as more likely…

by Barry M-C on July 29, 2011

That the US might default on its debts seemed wildly implausible when I first wrote on the subject “Will the US Government default on its debts?” just over two months ago on May 18th 2011.  As I noted then,

A US default is a long way off but with no agreed bi-partisan plan to contain and reduce the debt, nor any plan to tackle the structural budget deficit by reducing spending, the growth of the U.S. government’s debt is clearly making markets nervous and making the debt more costly to fund.

Most commentators discounted the notion that a default was plausible but as Congressional Leaders and President Obama’s administration continue to try and hammer out a deal to raise the $14.3 trillion debt ceiling before the 2nd August deadline, what was considered implausible is now a very real possibility that is spooking the markets, with the Dow falling everyday this week.  Now, tonight (28/07/11), Reuters are reporting how:

Britain’s borrowing costs fell below equivalent U.S. rates for the first time in almost two years on Thursday as worries over the risk of a U.S. debt default took the shine off Treasuries in favour of British gilt-edged securities.

A Republican deficit reduction plan headed to a close vote in the U.S. Congress and the White House urged divided lawmakers to clinch a compromise deal to head off the risk of a debt default by the world’s largest economy.

A failure to raise the debt limit by an August 2 deadline could trigger a crippling default that would shake the global financial system and could tip the United States back into recession.

While most analysts hope a default will be avoided by an eleventh-hour deal, the risk remains for a damaging downgrade of the United States’ top-notch credit rating, a move that would raise U.S. borrowing costs and rattle global investors.

(Reuters: “UK debt costs below U.S. costs for the first time in 2 years“)

A deal may be done – and surely will be done – to raise the debt ceiling by (or just after) the 2nd August deadline but the strength of those within the Republican Congressional ranks opposed to any deal which doesn’t impose significant enough cuts to government spending is revealing.  Indeed, tonight (28/07/11) the Speaker, Rep. Boehner, has announced that he hasn’t the votes to get the GOP’s debt plan through the House.  Furthermore, as Cato’s Michael Tanner notes this week, neither Speaker Boehner’s debt plan nor the Senate Majority Leader, Democrat Harry Reid’s debt plan actually entail much austerity in government spending.  As Tanner writes:

[B]oth Reid and Boehner are using the time-honored Washington dodge of “baseline budgeting,” meaning that the proposed cuts are not actual reductions in spending from year to year, but cuts from projected future increases. Thus, under both the Reid and Boehner plans, actual federal spending will continue to rise.

US raids civil service pension fund as it hits $14.3 trillion debt limit - The Telegraph, 16/05/11

The Republican Congressional opposition to raising the debt ceiling without sweeping cuts in government spending reflects a party emboldened and reinvigorated by the TEA Party.  Its advocates draw upon that great libertarian heritage of small government and low taxes that established America; their arguments informed by think tanks and scholars; their agenda responding to the public’s gowing awareness that the U.S. government is living beyond its means.  For all of the Democrats’ posturing – Senate Majority Leader Harry Reid has promised to defeat any Republican debt plan immediately that the House sends it to the Senate – the debt ceiling crisis is in reality good news for Americans.  Whereas the Greeks have been plunged into a deepening crisis that the repeated bailouts have merely exacerbated rather than solved because they have repeatedly failed to tackle their underlying budgetary problems by reining in and reducing government spending, the U.S.’s debt ceiling crisis is prompting earlier action, when the U.S. still has significant leeway in which to get its finances in order.

What the crisis also marks is an ideological division between those U.S. lawmakers (like Presidents George W. Bush and Barack Obama and Senate Majority Leader Harry Reid) who would raise taxes to bridge the fiscal gap, bringing U.S. tax rates and government spending into line with European levels, and those lawmakers (like Ron Paul and many of those elected in 2010 with Tea Party support) who would not only balance the nation’s books by cutting spending but who would cut spending to such levels that taxes could also be significantly reduced.

Indeed, the sooner that the U.S. government starts to tackle its budget deficit the sooner that it can start to tackle the tens of trillions of dollars of unfunded liabilities within the Social Security and Medicare/Medicaid programs – the scale of which dwarf the present national debt ceiling of $14.3 trillion.  Unfortunately, for the President, the markets don’t believe that his administration is willing to curb its addiction to spending and its over-reliance on increasing taxes – despite the valiant efforts of many House Republicans and the Tea Partiers – and that’s why the cost of U.S. government borrowing is rising.

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