US once again bowed under debt ceiling

After only just getting over the US Federal Reserve's decision not to begin tapering, global markets must now confront the risk of a US default.

After only just getting over the US Federal Reserve's decision not to begin tapering, global markets must now confront the risk of a US default.

The US government is again fast approaching its debt ceiling - the total amount of money it is allowed to borrow to meet obligations.

If the debt ceiling is not raised, the risk of the US defaulting on its debts will increase exponentially.

The government has been scraping up against its $US16.7 trillion ($17.8 trillion) debt limit since May but has avoided defaulting on any bills by employing emergency measures to manage its cash. The non-partisan Congressional Budget Office predicts the limit will be hit in mid-October or November.

If the US were to default, confidence in the world's largest economy would be rocked. It would probably result in a downgrade of the nation's credit rating, which was lowered for the first time during the last debt-ceiling negotiations, in 2011. This would increase US borrowing costs and the risk of another recession and higher unemployment.

This would no doubt cause a rally in the Australian dollar, which would be a headache for policymakers here. A higher Australian dollar has been crimping the domestic economy and the Reserve Bank is expected to be increasingly cautious when it comes to lowering official cash rates. Even so, a rush of international money would flow into AAA-rated Australian government bonds - pushing down borrowing costs for Canberra.

While there is a lot of noise around the debt ceiling being hit, economists mostly expect the limit to be raised. According to the US Treasury, Congress has acted 78 times since 1960 to avoid a default. "Congress has always acted when called upon to raise the debt limit - 49 times under Republican presidents and 29 times under Democratic presidents," it said.

US government gross debt is 106.5 per cent of gross domestic product (GDP), according to the International Monetary Fund.

By comparison, Australia's debt to GDP is 27.2 per cent, Greece's is 158.5 per cent and Japan's 230.3 per cent.

It is unlikely that Republicans and Democrats will knock back a rise in the debt limit. Rather both parties will be playing a dangerous game of brinkmanship for their respective political agendas.

Republicans will push for more cuts to government spending while Democrats will want to raise the limit high enough to get them through the next House of Representative elections in 2014.

Obamacare is also likely to be debated extensively.

Raising the debt ceiling does not cut government spending, as the money borrowed funds the government's existing legal obligations. These are expenses the government has already committed to over the years under different administrations. They include things such as public servant salaries, interest payments on debt, tax returns, Social Security and Medicare.

Investors will also be keeping an eye on US discretionary spending authorisation, which is due to run out on September 30, though it is likely Congress will pass a continuing resolution until November and hold negotiations at the same time as those for the debt ceiling.

Discretionary spending authorisation is part of the budget, which is approved by Congress, and is optional. Spending on existing obligations, covered by a rise in the debt ceiling, is mandatory.

Deutsche Bank economists said if a continuing resolution was passed in time, or if the government closed for only a day or two, the probability of a debt ceiling deadlock would be reduced.

"Critically, under no circumstance do we expect the Treasury to default on its obligations."

White House budget director Sylvia Burwell has already instructed executive branches to make contingency plans for a shutdown.

"If a shutdown occurs, the government will still service its debt, but like the late 1995-early 1996 government shutdown, we expect most federal employees to be unpaid and not to work," said analysts at ratings agency Moody's, adding that at this stage the agency would stick with its Aaa stable rating.

While not raising the debt ceiling could have disastrous implications for the world economy and financial markets, the likelihood of that happening is low.

Westpac economist Elliot Clarke said the mostly likely outcome would come from last-minute negotiations as the Republicans and Democrats each tried to gain leverage over the other.

"The Democrats might agree to provide another sequester to reduce spending a little bit to appease the Republicans and get an increase [in the debt limit], which should get them through the next year or 18 months. That would get them past the next house elections, which are late next year," Mr Clarke said.

While extremely unlikely, if both parties cannot agree to raise the debt ceiling, US President Barack Obama can step in and use his executive powers.

"The implication there is that it hasn't even been done before, and it's quite untested, so that might lead to not only a lot of angst within the house but may lead to court proceedings as well," Mr Clarke said.

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