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Commentary

The US Shuts-Up

I’ve not written much about the US Shutdown and the Debt ceiling negotiations, largely because it has been pointless. The shutdown was because the houses refused to pass the budget, an event that in India would cause the government to resign. The republicans, who control the lower house (equivalent to the Lok Sabha) wanted restrictions on Obama’s healthcare for everyone program in terms of not giving it money, while the upper house (Senate) controlled by Democrats – Obama’s party – didn’t want that to mix with the debt ceiling/shutdown negotiations.

None of this is useful in isolation. The US had a debt ceiling negotiation in 2011, when Obama had to concede defeat and negotiate on other topics. Which makes little sense, because the US simply cannot afford to not raise its debt ceiling.

The debt ceiling in a nutshell: Governments borrow. And to pay back the principal and interest, they borrow more. This ponzi scheme is played by the worldwide banking system. It cannot be stopped by not allowing them to borrow, which has massive collateral damage; instead, they should be penalized by higher interest rates) The debt ceiling makes a fixed dollar limit on the amount the government can borrow, which means that if it can’t borrow to pay back other debt, it will end up defaulting on that debt.

The republican position is that the government’s borrowing too much. But instead of stopping the plans (like Obamacare) themselves – which they could not, even the Supreme court upheld it as legal – they decided to attack the source of funding instead. What use would a program be if there was no money to fund it? That was their initial stance on the debt ceiling and government shutdown.

Increasingly, that position because untenable as the shutdown impacted businesses (the republicans’ primary support base). More than $24 billion has been lost as the government shut down museums, furloughed contractors and cut down programs like the FDA. The republicans responded by saying they would support piecemeal opening up of government like defense, FDA and other such services – but Obama took on a tough stand, saying this makes no sense and it would have be all or nothing.

The debt ceiling deadline was October 17, after which no further debt would cause potentially serious problems. An actual default would likely occur only on November 1, when a large repayment was due. But before that, the government would find it difficult to get money for regular spending (despite the shutdown).

This was also unpalatable – people have money in pension funds that invest in government securities, and a default will hurt them. It would hurt relationships abroad where countries have bought government debt as backed by the full faith of the US government. It would hurt the regular joes, the banks, the sovereign wealth funds and the power of the dollar as a transactional currency worldwide – and thus, erode all republican support.

But could the republicans give up without a fight? They started the battle. They had firmly said they wouldn’t raise the limit without some concessions. Obama refused to even talk about concessions, because raising the limit or reversing the shutdown were non-negotiable – they could discuss “after”. There were no political brownie points for the republicans either way – cave, and they look weak, or stand firm, and they are blamed for a disaster.

They caved, and in the process didn’t do anything really constructive. According to Bloomberg, while the government has reversed the shutdown (hence the sad pun on the title of this article), it has set up a budget fight for December 13, 2013 and suspended the debt limit till February 7, 2014.

There are elections for house seats in November 2014. Their position remains weak, so republicans will attempt to save face, or win a battle next year. If the democrats stare them down again, the stakes are even higher – cave a second time, and you’re guaranteed to lose elections; don’t cave, and let the US default?

The Impact to India: A default would hurt, because it would hurt everyone. And the RBI owns about $60 billion of US debt securities. Markets actually went up because no one thought the US would default – therefore, in the presence of a potential deal, it was time to party.

However, like most turkeys, we don’t know when we will be fat enough to be slaughtered. So it’s all good till it’s not, and the consequence of a negative is so bad that there’s no point staying out – you can’t save your money if the US is going bust. But what you can expect is volatility.

The US shutdown would have hurt a few sub-contractors in the IT space, but only temporarily. But that impact seems to be small.

Tapering the US Fed QE3 might be delayed till JFM 2014, which is good in that we get a few more months of the liquidity drug. That can however change overnight, based merely on some statements.

Overall, this is a very boring piece of news, more political than economic. Which is why I’ve ignored it, especially in the Indian context. The key takeaway is: Life moves on.

  • D Rama says:

    Deepak,
    The debt ceiling in a nutshell: Governments borrow WHEN THEIR EXPENSES EXCEED REVENUE AND TAX COLLECTIONS. And to pay back the principal and interest AND TO FINANCE ADDITIONAL EXPENSES, they borrow more.
    Fixed it for ya!
    Please be aware that not raising the debt ceiling does NOT automatically imply that default will follow. Default occurs only when Govts are unable to pay interest on and repay principal of EXISTING debt. What a cap on debt ensures is ONLY that Govt budgets MUST become balanced i.e. expenses <= (revenue + tax collections).
    Request you to read few articles by Karl Denninger (www.market-ticker.org) which is a treasure trove of info on US Economy, Govt, and local & global economic issues.