US Obamacare crisis triggers dire warnings
They are not so much shadow-boxing as an attempt to settle a world championship fight in the preliminary bout instead of the championship bout itself.
The US government began a partial shutdown on Monday afternoon Australian time after lower house Republicans refused to pull riders they had attached to this year's budget supply bill that would have delayed and undermined the Obama administration's overhaul of America's health insurance system.
The partial shutdown works like a steadily tightening vice on the US economy. As it continues, America's economic recovery weakens.
The really big risk, however, is that the blocking tactics the Republicans are using to try to roll back President Barack Obama's health reform package will be used again when Congress votes on raising the government's $US16.7 trillion ($17.7 trillion)debt limit.
They are sending mixed messages, and the ceiling is expected to be reached on October 17. If it has not been raised by then, a brief countdown to what is being described as a "technical default" by the US government on debt that is already issued will begin.
About mid-November, the government would fail to financially cover interest payments on a tranche of debt. Distinctions between a so-called "technical" default and a real default would at that point become meaningless as news that the world's most important debt issuer had failed to cover its obligations sent shockwaves around the world.
There would probably be massive forced selling as the default triggered bond fund mandates that specify that only top-rated, untainted securities can be owned. There would certainly be panic selling, on the shock of a default by the government considered safest of all in times of crisis.
The Treasury Department trumpeted the risks in a paper it issued on Thursday night our time. America had never defaulted on obligations, it said, and the US dollar and US government debt sat at the heart of the global financial system.
"A default would be unprecedented and has the potential to be catastrophic: credit markets could freeze," it warned. "The value of the dollar could plummet, US interest rates could skyrocket, the negative spillovers could reverberate around the world, and there might be a financial crisis and recession that could echo the events of 2008."
The International Monetary Fund is holding its annual meeting in Washington next week, and IMF managing director Christine Lagarde issued a similar warning, saying raising the debt ceiling was "mission critical ... the government shutdown is bad enough, but failure to raise the debt ceiling would be far worse, and could very seriously damage not only the US economy but the entire global economy".
America has once again climbed away from a financial and economic crisis more quickly than many expected. Its annual budget deficit as a percentage of gross domestic product (GDP) has already halved from its global-crisis high to less than 5 per cent.
As it bumps up against the existing $16.7 trillion debt ceiling, Washington's total debt load is still uncomfortably high at about 75 per cent of GDP compared with 36 per cent in 2007 before the global crisis erupted.
Like the Democrats, Ms Lagarde argues, however, that heavy budget cuts and a choke on government borrowing at this time would be counterproductive. The US needed "less fiscal adjustment today and more tomorrow", she said on Thursday.
One of the uncertainties in the situation is that logic is not necessarily central to the tactic being deployed by the Republican attempt to use the budget bill as a way to attack Obamacare - a health industry restructure that has been passed by both houses of Congress, unsuccessfully challenged in the nation's highest court and implicitly endorsed by voters in the election that secured President Obama a second term in November last year.
Some members of the faction have also been quoted as saying they do not believe a debt default would be catastrophic.
As the government shutdown began on Monday, polls were already showing that more people blamed the Republicans for the mess than blamed the Democrats, however, and the pressure is ratcheting up as authorities warn a market meltdown is possible.
It is difficult to see a resolution of the crisis if hardline Republicans do not come to believe that their tactics are extracting too heavy a toll on the US economy - and also on their own party's standing. The warnings of the consequences of them not doing so are ramping up because the time for them to do so is now, when the fulcrum is the US budget blockade and the gradual economic slowdown it is causing, rather than the larger crisis that would loom if the debt ceiling negotiations also failed.
So far the markets are betraying concern rather than outright fear. Wall Street's Dow Jones Industrial Average of 30 blue-chip stocks and the broader Standard & Poor's 500-stock index both fell by 0.9 per cent on Thursday as Treasury and the IMF issued their warnings.
They were down 2.2 per cent and 1.2 per cent respectively over five days, but were still up 14.4 per cent and 17.7 per cent respectively in the year to date. Europe's benchmark Euro Stoxx index was down 0.7 per cent over five days but still up 10 per cent in 2013, and Australia's S&P/ASX 200 benchmark index was down 2 per cent over five days but up almost 12 per cent for the year.
The relatively modest moves this week reflect a belief that a deal will be done, allowing accumulating evidence of a global economic recovery to reassert itself. The deal must end the budget roadblock and clear the way for an increase in the government's borrowing limit to be effective, however - and it must be forged by the Republicans and Democrats by the end of next week at the latest to avoid the onset of panic in global markets.
mmaiden@fairfaxmedia.com.au
Frequently Asked Questions about this Article…
The article says the partial shutdown began after lower-house Republicans refused to remove riders from this year’s budget supply bill that would have delayed elements of President Obama’s health insurance overhaul (Obamacare). For investors, a shutdown tightens the economy and weakens recovery — the piece warns it could escalate market concern and, if prolonged, harm confidence and asset prices.
The US debt ceiling at the time of the article was about US$16.7 trillion. It was expected to be reached on October 17; if not raised, a countdown to a so-called “technical default” would begin. Investors should care because failure to lift the ceiling risks missed interest payments, potential forced selling in bond markets, and broad market shock.
The Treasury warned a default would be unprecedented and could be catastrophic: credit markets could freeze, the value of the dollar could plummet, US interest rates could skyrocket, and negative spillovers could reverberate globally — possibly triggering a financial crisis and recession comparable to 2008.
The article explains that a default would probably trigger massive forced selling because many bond fund mandates allow only top-rated, untainted securities. Loss of that ‘safe’ status could force funds to sell US government debt and prompt panic selling across fixed-income markets.
IMF managing director Christine Lagarde called raising the debt ceiling “mission critical.” She said the government shutdown is bad enough but failure to raise the debt limit would be far worse and could seriously damage both the US and the global economy.
Markets showed concern rather than panic. On the Thursday cited, the Dow Jones Industrial Average and the S&P 500 each fell about 0.9%. Over five days the Dow was down 2.2% and the S&P 500 down 1.2%, though both remained well up year-to-date (about 14.4% and 17.7% respectively). Europe’s Euro Stoxx was down 0.7% over five days but up ~10% YTD, and Australia’s S&P/ASX 200 was down 2% over five days but up almost 12% for the year.
The article noted that if the debt ceiling is not raised by the projected October 17 date, a short countdown to a “technical default” would begin. By about mid‑November, the government could fail to make interest payments on a tranche of debt, at which point distinctions between a technical and a real default would likely become meaningless.
Based on the article’s analysis, investors should watch negotiating progress in Washington (whether the budget roadblock is cleared and the debt ceiling increased), Treasury and IMF warnings, rising market volatility or sudden moves in bond yields, and any forced selling in bond funds. The piece also notes polls blamed Republicans more for the shutdown, signalling political pressure that can influence the speed of a resolution.
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