Markets are set to be on edge in coming weeks as US lawmakers thrash out the highly politically-charged issue of increasing the US debt ceiling.
Overnight, US Treasury Secretary Timothy Geithner fired off a letter to US lawmakers indicating that the US could reach its debt limit of nearly $14.3 trillion as early as March 31, and warning that failure to raise the debt limit could “precipitate a default by the United States”.
Geithner made it clear that a failure by the US government to meet its financial commitments would roil global financial markets. “Default would have prolonged and far-reaching negative consequences on the safe-haven status of Treasurys and the dollar’s dominant role in the international financial system”.
It would also be disastrous for the US economy. “Even a short-term or limited default would have catastrophic economic consequences that would last for decades”, the letter said.
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But the newly appointed Republican Speaker of the House John Boehner refused to be intimidated by Geithner’s dire warnings. He said that Americans would not stand for any further increases in the debt limit unless they saw decisive spending cuts.
“While America cannot default on its debt, we also cannot continue to borrow recklessly, dig ourselves deeper into this hole, and mortgage the future of our children and grandchildren,” he said.
The debate over increasing the debt limit is likely to be especially heated this year, as a result of the change in the political balance in Washington. During the election campaign, many Republican candidates lashed out at their opponents for voting to lift the debt ceiling last year, and vowed to vote against lifting the debt ceiling when US government borrowings hit its current limit.
In addition, recent changes to voting procedures put individual lawmakers under greater scrutiny. Lawmakers now have to go on record in support of raising the debt limit, which lays them open to the charge of being profligate spenders. Alternatively, they can vote against it, and risk plunging the country into default. Previously the debt ceiling was increased as part of the annual budget process.
Despite the political posturing, most observers are confident that US lawmakers will approve an increase in the debt limit. The closest the US came to a debt limit default was in 1995 when Republicans forced a partial government shut down over the issue. Republicans suffered a voter backlash in elections the following year.
But the emotional nature of the debate is likely to highlight the extremely fractious political situation in Washington.
According to John Taylor, chief investment officer of FX Concepts, the world’s largest currency hedge fund, financial markets have so far been remarkably relaxed about the prospect of US political gridlock.
“The general nonchalance regarding Washington’s knotty political situation seems to derive from the historical fact that things tend to go rather well when the power in Washington is so diffuse that no one party has the power to move things in any direction at all.”
But, he says, the mood in Washington is likely to turn hostile.
The 112th Congress has just begun, he says, “but House Republicans have already laid out plans that are aimed at rolling back or not funding as many of the Obama programs as they can.”
“As the Democrats control the Senate and the President has the veto as well, the programs are likely to survive the House challenges. However, these divisive tactics assure that pleasantries will be hard to come by in the Congress during the next year.”
As a result, he says, if the US economy hits problems, “it will be almost impossible to get a decision.”
“Trench warfare is what we see and a deep recession is what we fear. Even growth below 2.5% would be very problematic and a big disappointment for the markets. Although we see equities down significantly, the dollar should rally and commodities decline as the US economy slows.”
This article first appeared on Business Spectator.