US Strategic Debt Default; Republican Political Suicide

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					Republican lawmakers have floated the idea of attaching a balanced budget
amendment to the bill that would increase the U.S. debt ceiling before it
is sent to President Obama for signature. This would put the President in
a position of having to sign the bill to increase the debt ceiling and
balance the budget in order to avoid a U.S. Government debt default.
While everybody would like to see the U.S. balance its budget, now may
not be the best time. This would be a lose/lose situation for everyone.
If Obama did sign the bill balancing the U.S. budget, the fragile U.S.
economy, along with the frail debt situation in Europe and coupled with
the slowing economy in China could have dire consequences. Forcing the
U.S. government to balance its budget would mean massive government
layoffs and spending cuts to different types of programs. One third of
GDP is made of government spending. This would most certainly put the
economy back into a recession.While the intentions are good and the idea
is good, now is not necessarily the best time. If Obama does not sign the
bill then the U.S. will have to default on one of its interest payments;
be it only a three-month treasury bill, but nonetheless it is still a
default. If after 2 weeks the debt ceiling is not raised, then there
would be another interest default as well as a principle default.Moody's,
Fitch and S&P have come out and stated that they would downgrade U.S.
debt if the U.S. missed an interest payment; all said they would
downgrade the debt as August 2nd approached and the debt ceiling is not
raised. Fitch went as far as saying that they would downgrade all U.S.
debt to junk status if the payment was not made on August 2nd.Many
countries buy U.S. debt because it is considered the safest in the world.
The slightest hint of that not being true could send ripples throughout
the World's marketplaces. Some smaller countries that own large amounts
of U.S. debt could find themselves in dire straits. They use U.S. bonds
as assets to borrow funds as well as the interest payments as income.
Their budgets depend on the income from those bonds.An independent
advisor to the People's Bank of China, Li Daokui, stated publicly that
the U.S. Republican lawmakers "are playing with fire". Additionally, a
Chinese Academy of Social Sciences researcher, Yuan Bangming, stated that
Republicans in the U.S. just want to make things difficult for Obama.
Whatever the reasons, China is deeply concerned; and should be, they own
over $1 trillion of U.S. debt. It would be catastrophic to their economy
if there was a downgrade or default on any U.S. debt.If there was a
default or downgrade, interest rates would climb dramatically. All funds,
be they mutual funds, hedge funds or sovereign funds that hold U.S. debt
would be required to either downsize or liquidate all of their U.S. debt
holdings. Some funds are required by their charter to hold only a certain
grade of debt while others create risk profiles for which layers of
various debt grades make up certain percentages of the fund. When these
funds sell their U.S. debt holdings in droves, it would force bond prices
lower increases interest rates.Look at Greece, their debt is now
commanding a 24% interest rate. The U.S. has $14 trillion in outstanding
debt. If interest rates are forced up by ratings downgrades, interest
payments would climb and the U.S. would never be able to get out of debt.
Even if the interest rate for all of the United State's debt increased
only three percentage points it would be catastrophic. U.S. interest
payments every year would be so huge that it would take that many more
years to get out of debt, making a bad situation worse and burdening many
more future generations with the debt of today.If the Republicans truly
are doing this to make Obama look bad, it could very easily backfire on
them. By playing political wrangling games and risking the threat of
default that cause downgrades, Republicans could easily catch the
blame.Chris Whalen, of Institutional Risk Analytics, has come out
publicly and stated that he hopes that Congress does not raise the debt
ceiling unless President Obama agrees to sign a balanced budget
amendment. Mr. Whalen is very smart and extremely well respected in the
risk industry; however, he may not have thought it through completely.
All we have to do is look back at the Lehman crisis; no one thought that
would get out of hand. Everyone thought that a buyer would step in and
the assets would be bought and nothing would come of it, at least nothing
to that extreme.Once a debt downgrade starts it is extremely difficult to
stop. We have seen it happen several times in recent history. Lehman
being the best case in point. Greece's debt ratings decreased, interest
rates increased, making it more difficult to pay down the debt. There is
no temporary default, there is no brief debt default, once it starts it
cannot be stopped. There is no such thing as a "little" pregnant; a
default is still a default.Republicans hope to get somebody viable to
beat Obama in the 2012 election. They also hope to win a majority of the
Senate and keep their majority in the House. There is much rhetoric and
hatred for the current administration. While no one administration is
perfect, they need to do what is best for the country and in this case
the world.While long-term U.S. debt reduction is important, it is more
important to maintain the credibility of the U.S. government and the
people of the U.S. If Republicans force their hand and force Obama to
sign a balanced budget agreement, nobody is going to win. Come election
time in a little over a year economics will be considerably worse.
Republicans will be blamed for putting forth such strict austerity
measures and forcing the government to downsize too quickly. Democrats
will be blamed for signing off on the bill.The only solution is to raise
the debt limit unencumbered by any other bills or any other restrictions
and move forward in a proactive way that will resolve the debt issues on
a longer-term basis. As they say, "you can win the battle but not win the
war." Republicans could win the battle and lose the war.

				
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posted:7/14/2011
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