u.s. debt ceiling crisis

7/27/2019 U.S. Debt Ceiling Crisis

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U.S. Debt Ceiling Crisis


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Introduction

On 2nd August 2011, U.S. President Barack Obamadeclared that the Republicans and the Democratshad reached a consensus on the debt ceiling issueand had agreed to pass a bill that would trim the

bulging sovereign deficit and raise the $14.3 trillionceiling by more than $2 trillion in extra borrowingpower, which will last till 2013. It paves way for about$2.4 trillion in spending cuts over next 10 years.These cuts will be implemented in two steps: the$917 billion agreed to initially, followed by anadditional $1.5 trillion that the newly formedCongressional Joint Select Committee on DeficitReduction is supposed to recommend by November2011.


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KeywordsDEBT CEILING: The legal limit on borrowing by thefederal government

BONDS: A bond is a debt security, in which theauthorized issuer owes the holders a debt and,

depending on the terms of the bond, is obliged to payinterest to use and/or to repay the principal at a laterdate, termed maturity

DOUBLE DIP: A double-dip recession refers to arecession followed by a short-lived recovery, followedby another recession

CREDIT RATING: It evaluates the credit worthinessof an issuer of specific types of debt, specifically, debtissued by a business enterprise such as

a corporation or a government.


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Keywords contd.

DEBT TO GDP RATIO: The debt-to-GDP ratio is oneof the indicators of the health of an economy. It is theamount of national debt of a country as a percentageof its Gross Domestic Product (GDP). A low debt-to-

GDP ratio indicates an economy that produces alarge number of goods and services and probablyprofits that are high enough to pay back debts.

CREDIT RATING AGENCY: It is a company that

assigns credit ratings for issuers of certain typesof debt obligations as well as the debt instrumentsthemselves.

DEFICIT: In economics, a deficit is a shortfall in

revenue to cover expenditures.


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U.S. Debt Ceiling: A Brief

HistoryWORLD WAR I

WORLD WAR II

1970

2003


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To whom does the USGovt. owe the debt ?

Domestically

US public : $3.6 trillion

Federal Reserve System : $1.6 trillion

Social Security Trust Fund: $2.7 trillion

Other U.S. Govt. Trust Funds: $1.9 trillion


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Internationally

China : $1.2 trillion

Japan : $0.9 trillion

Britain : $0.3 trillion

others : $2.1 trillion


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How did the U.S. debt get

so big?


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Standard and Poors CreditDowngrading

S&P lowered long-term sovereign credit rating onthe United Stated to AA+ from AAA.


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Credit Ratings Definitions

Credit ratings are forward-looking opinions aboutcredit risk.

AAAExtremely strong capacity to meetfinancial commitments. Highest Rating.

AAVery strong capacity to meet financialcommitments.

AStrong capacity to meet financialcommitments, but somewhat susceptible toadverse economic conditions and changes incircumstances.


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BBBAdequate capacity to meet financialcommitments, but more subject to adverse

economic conditions.BBB-Considered lowest investment grade bymarket participants.

BB+Considered highest speculative grade bymarket participants.

BBLess vulnerable in the near-term but facesmajor ongoing uncertainties to adverse business,financial and economic conditions.

BMore vulnerable to adverse business,financial and economic conditions but currentlyhas the capacity to meet financial commitments.


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CCCCurrently vulnerable and dependent onfavorable business, financial and economicconditions to meet financial commitments.

CCCurrently highly vulnerable.

CCurrently highly vulnerable obligations and other

defined circumstances.

DPayment default on financial commitments.

Note: Ratings from AA to CCC may be modified by theaddition of a plus (+) or minus (-) sign to show relativestanding within the major rating categories.


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Rationale behind the credit

downgrade

The US congress is not doing enough to stabilizethe governments medium-term debt dynamics.

The effectiveness, stability, and predictability ofAmerican Govt. has weakened at a critical

juncture.


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Standard and Poors is of the view that despitethe $2.1 trillion spending reduction, U.S. generalgovernment debt burden will grow in the future.

They could lower the long-term rating to 'AA'within the next two years if they see that lessreduction in spending than agreed to, higher

interest rates, or new fiscal pressures during theperiod result in a higher general government debttrajectory than they currently assume in theirbase case.

I di t ft th f


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Immediate aftermath ofcredit rating downgrade:

Serious Investor PanicMarkets plunged all over the worldthe BSE Sensex went spiraling down 316 points to below

17000 level for the first time in 14 months (June 2010). Itclosed at 16,990.18 points. As a result the market lostnearly Rs. 1,00,000 crore in a single day. Nifty fell to5200 and the metal, IT and realty stocks were worst hit.

Dow Jones fell 632 points, a drop of 5.5%, S & P 500index fell by 6.7%, the Nasdaq fell by 6.9%.

Gold rose 3.14% the next day, and continued to rise.


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The downgrade intended to signal to the globalmarket place that the U.S. was not as safe aninvestment as it had been in the past. Analystswarned that it could mean higher borrower ratesfor the U.S, higher interest rates for consumersand downgraded credit ratings for individualstates.


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The Gold Rush

As a result of the volatility in the stock markets,investors started looking at gold as a safe haven.It has touched a high of $1912/oz. Small and biginvestors are looking at gold as the safestinvestment as people are not sure where toinvest.


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Is a double dip recessioncoming?

GDP growth in the US has been slow


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Unemployment is quite high


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Due to the Republicans conservative stand, the

US government will be forced to implementspending cuts and withdrawal of stimulusmeasures rather than expansion.

They are opposed to the strategy of enhancedpublic expenditure, used by governments tocombat recession in the past. But there arent

any other alternatives available.


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What this would mean forthe rest of the world?

Global economies are interlinked and if the U.S.goes into a double dip recession, its tremors willbe felt all over the world.

The role of U.S. as an importer will becomediminished, especially if the dollar weakens.

Growing resentment among people about budgetcuts, welfare programs and unemployment willcreate protectionist pressures which will reboundon outsourcing.


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In June 2011, India exported goods and servicesworth nearly $30 billion. A third of these exportswent to U.S. and Europe. However, the export ofproducts was double the export of services in

April-June quarter this year.

Another problem for emerging markets like India,is the problem of mobile capital and policy

makers ought to be wary of it.


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If demand in the US or Europe goes down, thenmanufacturing exports from China, agriculturalexports from Brazil, services exports from Indiaetc., would all take a hit.

This will have a cascading effect on output,employment and investor expectation.


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u.s. debt ceiling crisis

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