With still no sign that Washington has been able to craft a compromise solution for raising the debt ceiling, global markets are becoming increasingly worried about the damage the stalemate is inflicting on the US economy.
A group of 14 Wall Street heavyweights, including Goldman Sachs’ Lloyd Blankfein and JP Morgan Chase’s Jamie Dimon, have voiced their concerns. In a letter to US President Barack Obama, they warned of the “very grave” consequences of failing to reach a quick resolution.
“A default on our nation’s obligations, or a downgrade of America’s credit rating, would be a tremendous blow to business and investor confidence — raising interest rates for everyone who borrows, undermining the value of the dollar, and roiling stock and bond markets — and, therefore, dramatically worsening our nation’s already difficult economic circumstances,” the letter said.
With only days left until the August 2 deadline is reached, financial markets remain confident the US will be able to avoid a debt default, but there is mounting anxiety that the US could be stripped of its precious triple-A credit rating.
Some participants are concerned that the US central bank has so far failed to outline its plans for supporting the US financial system if a default or downgrade were to trigger a run on money market funds, or disrupt the critical repurchase, or “repo” market.
Amid this uncertainty, money markets have already begun to hoard cash in case they experience a sharp rise in redemptions, while banks are building up their liquidity buffers.
As well, there are increasing signs that the bitter bickering in Washington is further sapping weak US business and consumer confidence. In particular, companies are freezing plans to hire new workers, and have postponed investment spending decisions.
Even if a last-minute solution to the debt ceiling is found, some worry that it is too late to stop the US economy from weakening even further. The latest Federal Reserve Beige Book, which is prepared for next month’s meeting of the Federal Open Market Committee — which makes important decisions on monetary policy — painted a dispiriting picture, with eight of the 12 Fed districts reporting slower growth, and four reporting steady growth. This represents a significant deterioration from the previous Beige Book, prepared for June’s meeting, which showed seven districts reporting steady growth, while one said growth had picked up, and only four reported a slowdown.
At the same time, the latest earnings season has seen a noticeable increase in the number of companies that were pessimistic on the outlook for their businesses.
Some worry that the deteriorating economy means that the US is headed for a debt trap, even if Washington reaches a deal for cutting budget deficits and raising the debt ceiling.
They point out that any additional government spending cuts or tax increases will inevitably cause the economy to weaken further. This will lead to further US budgetary strains, because a weaker economy will mean dwindling tax receipts, while the government faces a bigger bill for welfare payments. As a result, the budget deficit will swell further, and the US government will be forced to borrow even more money to cover the shortfall. But this growing debt burden will put even more pressure on the US government to make even more stringent budgetary cuts.
*This first appeared at Business Spectator.
How on earth would taking the tax on the very highest income earners back to what it was pre-Bush “inevitably cause the economy to weaken further”? Tax rates would still be near historical lows, and people on very high incomes save most of their incomes.
Cutting social support for those on low incomes would, however, would reduce demand because such people have no choice but to spend most if not all that they get.
In the circumstances of the US, with staggering extremes of wealth and poverty, the effects of spending cuts would be far more drastic than those of the proposed tax rises.
This item http://www.nybooks.com/blogs/nyrblog/2011/jul/29/can-obama-extend-debt-ceiling-his-own/ suggests that, with respect to servicing EXISTING debts, the US president might be able to enforce servicing — see section near “dishonor the nation by repudiating outstanding debts it has authorized the nation to incur”.
I’ve got no idea bout the reality on the ground in the US but I think as Malcom says, increases in high end tax would not hurt the economy as the article makes out by distributing more income to the lower rungs of the ladder.
And while they are at it, a bit of a cut on security expenditure probably wouldn’t hurt either. I would suggest they cut military spending by 80% and spend 1/3 of the savings on real foreign aid and they would improve their secruity position.
Phillip – thanks for that link. It’s the clearest exposition I’ve seen so far of the possible applicability of the 14th Amendment.