Nowhere to hide from US debt default

The picture is a worrying one for Australian investors if the impasse with the US debt ceiling is not resolved by the Thursday deadline (US time).
By · 17 Oct 2013
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17 Oct 2013
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The picture is a worrying one for Australian investors if the impasse with the US debt ceiling is not resolved by the Thursday deadline (US time).

If the debt ceiling is not increased, the US government is likely to default on the interest its pays on US treasuries, the bedrock investment for the world economy. Even though any default would likely be weeks away, sharemarkets around the world would fall in expectation of a default.

That would affect almost every Australian, not just those holding shares directly, as the typical superannuation fund has about half of its money invested in global and Australian shares. It would be similar to the collapse of US investment bank Lehman Brothers five years ago, which was allowed to fail, and marked the beginning of the global financial crisis.

However, analysts do not believe the doomsday scenario will come to pass. They say the most likely outcome is that a lifeline is negotiated in the US Congress, where the day that the US government runs out of money is pushed out further.

Craig James, chief economist at CommSec, said the US political impasse would be sorted out because "there is no alternative but to sort it out".

But pushing the problem into the future, rather than resolving it, would sap investor confidence and slow the US recovery, said Shane Oliver, chief economist at AMP Capital Investors. "Markets will worry whether the US government defaults or not because the US has to cut its spending regardless."

One possible outcome of a continuing impasse is that international investors could favour Australian government bonds as a "safe haven", Dr Oliver said.

Australia is one of the few countries with a AAA credit rating. But that would push the dollar's value higher and be bad for local exporters, he said. It could lead the Reserve Bank to cut interest rates.

Mark Tierney, manager of asset allocation at AustralianSuper, said if there was a default everything looks bleak but central banks around the world had learnt their lesson from the Lehman failure when the banking payments system froze globally. "I think there is not a shred of doubt that we would see a central bank response globally," he said.

"Central banks are not going to repeat the mistakes of Lehmans when they said that everything would be all right. [They] will have contingency plans ready to go."

They would firstly shore up bank balance sheets and then inject massive levels of liquidity into their economies to boost growth, he said. "From a superannuation fund viewpoint we are not prepared to jump onto the bandwagon and say this is going to be a disaster," he said.

In the unlikely event of a default, central banks would respond and although equity markets could hit lows, they could start to jump again quite significantly, he said. "We would view it as a buying opportunity."

Craig James said the Reserve Bank would ensure that interest rates remained low and investors should not react to short-term events, or they could just end up selling shares at the worst time.
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