US Debt Crush

SUBHEAD:Tensions rise on Capitol Hill as America runs out of money on August 2nd. By Dominick Rushe 3 July 2011 in the Guardian - (http://www.guardian.co.uk/business/2011/jul/03/tensions-rise-america-runs-out-of-money) Image above: From (http://www.homeownershiprevolution.com/).

Not so long ago, the Onion, America's satirical "newspaper", ran a story about what had happened to the real Barack Obama. You know, the one who was all about change and "the audacity of hope". Apparently, he had been kidnapped by an imposter bent on destroying the president by turning him into a "wishy-washy loser". But with another election looming, and a new financial crisis brewing across the Atlantic, the old Obama seems to be back.

By 2 August the US must raise the legal limit on its $14.3 trillion debt or face dire consequences, and Republicans and Democrats have been locked in battle on Capitol Hill. With the crunch deadline approaching, Obama hit out at Republicans last week, saying they favoured corporate jet owners over children and the elderly. Those high-flying fat cats got six mentions in a speech that set out the president's combative stance.

"Before we ask our seniors to pay more for healthcare, before we cut our children's education, it's only fair to ask an oil company or a corporate jet owner that has done so well to give up that tax break that no other business enjoys," Obama said.

The Republicans came back just as hard. Fired up by rightwing, Tea Party-backed newcomers, the Republicans now control the House of Representatives. House speaker John Boehner said Obama was "sorely mistaken" if he believed he could muster enough votes to raise the debt ceiling and raise taxes. "The votes simply aren't there, and they aren't going to be there," Boehner warned. So bad have things got that the politicos are working tomorrow, on 4 July, the Independence Day holiday.

All this political posturing is about to have very serious consequences, according to economists. Some are predicting a second recession if it doesn't get sorted out soon. But, as the deadline approaches, both sides seem, if anything, to be toughening their stance.

It takes two votes to keep America's finances running: one vote to pass budget bills, another to borrow the money. There have been plenty of rows about the borrowing limit in the past. But after conditions are imposed and compromises reached, the limit has always been raised before the US treasury ran out of cash. This year may be different. With US debt at levels unseen in 60 years, Republicans are insisting on at least $2tn (£1.25tn) in spending cuts over 10 years and no tax increases.

If a deal cannot be reached before 2 August, the treasury says it will be forced to default on its debts. No one knows quite what that means yet. Will it choose to stop paying interest, a move that could trigger a global financial crisis? Or will pensioners, soldiers, contractors and other government workers find Uncle Sam welching on his bills?

Either way, economist argue, already jittery financial markets could go into meltdown. "When you start to voluntarily jeopardise the perceived integrity of your government in financial markets, you are creating long-term difficulties. People are never going to forget this," said David Levy, chairman of the Jerome Levy forecasting centre.

Last week 235 senior economists wrote to Washington's bigwigs, warning: "Reaching the limit on total outstanding debt could force a dramatic and sudden cut in federal spending that would destroy jobs and threaten the recovery."

Mark Zandi, chief economist at Moody's Analytics, said: "Our biggest problem now is the fragile nature of the recovery. Confidence is lacking. If anything goes off track, people freeze." He predicts that if the row continues on into July, financial markets – distracted in recent weeks by the shenanigans in Greece – will start to get more and more unsettled. "If we get to August, things will get a lot worse."

Even if an agreement cannot be reached, the US could afford to pay interest on its debts. Of every dollar the US spends, about 60 cents comes from revenues, such as taxes, and 40 cents is borrowed money. If the US gets to August and has not raised its borrowing limits, it will have to decide where to cut that 40 cents. Not paying the interest on its loans is a "nightmare scenario", says Paul Ashworth, chief US economist at Capital Economics. Markets could go haywire, with global consequences.

But the interest rate payments probably amount to 5-10 cents of that dollar, Ashworth calculates. "Even with 60 cents you could pay that. But that means massive cuts to the rest of spending. Contractors, social security, unemployment, tax rebates. Spending in the overall economy would plummet, with severe consequences."

According to the Washinton-based Bipartisan Policy Centre, if an agreement is not reached soon, the US will no longer be able to pay all its bills somewhere between 2 August and 9 August. The consequences would be immediate and "harrowing". Federal spending would have to be reduced by as much as 44% for the remainder of the month as the treasury prioritises payments to remain under the debt limit. Choices would have to be made between paying $49.2bn in social security benefits, $34.6bn in defence spending, and $12.8bn in unemployment benefits. Rating agencies, having already threatened to downgrade US debt, would probably do so. Double-dip recession, here we come.

With so many lining up to paint such a nightmarish picture, it's a wonder the political elite is not lining up to call for a solution.

"All we need now is an agreement on a broad outline on reductions in the deficit," said Zandi. "The election is the referendum on how to achieve that goal."

With 17 months still to go, that election has already begun. The reinvigorated Obama is up there championing pensioners against the jet set; his Tea Party haters are calling for greater responsibility and an end to Obama's "socialism". By the time summer hits its height, the consequences of this spat could be felt around the world.

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