Crikey business and media commentator Glenn Dyer picks apart the US debt ceiling impasse and what it means for the economy
Will the debt ceiling derail the US and global economies? The International Monetary Fund believes the situation will be resolved, but it warned overnight that if it’s not, then the chances of it damaging the US economy are great, and the rest of the world won’t escape the impact.
In fact, the IMF said that if handled badly, the debt ceiling has the capacity to wipe out global growth and trigger a recession. The IMF said the world economy will grow by just 2.9% this year and rise to 3.6% in 2014, a drop in estimates since July when it had forecast growth to be 3.2% this year and 3.8% next year. The IMF also cut Australia’s growth estimate by 0.5% to 2.5% for this year and 2.8% in 2014). The stakes are rather high.
There’s a growing confusion and Wall Street, reflected over two days of triple-digit falls for the Dow. Much of that confusion is flowing from a lack of understanding about what might happen if the debt ceiling isn’t lifted. In fact, while some alarmists claim it will trigger a mass sell-off and huge losses, the most likely outcome is likely to be stunned silence and “what do we do now”, and perhaps a panic.
But there is an important point to be made first — failure to repay a maturing bond or make a scheduled interest payment (coupon payment) on US Treasury bonds, bills or notes won’t necessarily be a default, no matter what some alarmists might claim. Payments and maturities can be deferred and the affected securities allowed to continue trading. Maturing securities are another thing, but they can also be deferred in a way that doesn’t disadvantage the holder.
That means the huge US money markets — especially the bond market — won’t freeze. Trading will continue in securities not affected by default, and some US economists and analysts reckon that even in those bonds and notes where there has been a payment missed, trading can continue — it has happened in the past (most notably in 1979), without affecting the wider market.
And, more importantly, unlike the debt of all other major countries, US debt does not contain what are called “cross default clauses”. These clauses stipulate that default on one bond is an automatic default across all debt, which would indeed be catastrophic for it’s standard in nearly all corporate debt. That means that if the US doesn’t repay debt maturing after October 17, or misses a scheduled interest payment (and there are US$557 billion of such payments due), it won’t push all US$11.9 trillion of publicly held US debt into default and trigger a global slump.
Several trillion of debt is held by the US Federal Reserve through its three versions of quantitative easing. The US central bank would not push the issue if any of its holdings suffered a missed interest payment or matured and wasn’t settled immediately.
That’s the good news and US Treasury Secretary, Jack Lew is due to provide more details of how his department will juggle payments and deferments overnight. But the situation will be confused and it’s no wonder that one-month US debt yields soared overnight to around 0.26% (and over 0.30% at one stage as investors sold their paper and retreated into cash).
That doesn’t sound like much, but there’s now the situation that US and other banks (say from AAA rated Australia) can borrow more cheaply for a month than the US government with the key London Interbank Offered Rate around 0.17%. That tells us how nervous big investors are, rightly or wrongly.
The IMF’s chief economist, Oliver Blanchard said in Washington that if US politicians failed to resolve their arguments over the budget and public debt, the result would be “an extreme fiscal consolidation and [this would] almost surely derail the US recovery” with wider global disruption. “If there was a problem lifting the debt ceiling, it could well be that what is now a recovery would turn into a recession or even worse,” he warned.
There’s still a way to go and there’s no doubt the impact would eventually be dramatic. Lew is likely to reveal how a series of selective payments and deferrals will be done to try keep the system going by not stopping all payments. He is tipped to reveal that bonds with missed payments will be stripped up into two parts — the delayed section where the payment has been missed, and ‘normal’ where future payments are still expected in coming quarters. That can be done under existing market rules.
Of interest will be how he and Treasury plan to juggle US$129 billion of payments for things like social security and hundreds of billions of dollars in payments due on bonds (maturing and on interest rates).
It has to be remembered that the US Government’s debt ceiling was hit several months ago and the Treasury has spent months juggling its cash flows and raiding contingency and other reserve funds to continue payments. But the US Treasury’s ability to continue doing that is now running out because there is a wall of payments and debt maturities to meet from next week through to the middle of November — some US$686 billion or so — and little or no cash available in coming weeks to meet all these payments.
Data provided by banks in New York, such as HSBC, have identified US$129 billion in Treasury payments due for payment from October 23 to November 16. These include payment for items such as social security, medicare, military payments, bond coupon payments and interest on Treasury bills. There are a further US$557 billion in Treasury bonds and bills maturing from October 17 (US$120 billion of short term bills) to November 15 (US$33 billion of maturing short term bonds with a coupon of 0.25%).
On October 23, a US$12 billion social security payment must be made, followed by a US$6 billion interest payment on October 31. On November 1, a rather large US$67 billion payment must be made for social security and others.
Dealers say there are already systems in place in the US to handle selected defaults. Maturing securities can be treated on a ‘when settled’ basis and not traded. And the impact will be small at first, but by around mid-November, could amount to US$3 trillion of issued bonds being caught up in the situation, part of the US$11.9 trillion of publicly held bonds and securities. Bond and notes with coupon payments that are outside the October 17 to November 15 period are continuing to trade unaffected and bonds and notes with longer maturities (2014 and beyond) are not impacted at the moment.