Global worries grow over possible US debt default

As the partial US government shutdown ran into the second week yesterday, the world is now getting more worried about a possible US default. Though the rhetoric between President Barack Obama and Republican leaders has grown more divisive, investors still believe they will reach a deal on the budget as well as the debt ceiling, but are also wary of the risk that it might just not happen.

The roots of the current crisis run deeper into the “reverential wisdom of the Founding Fathers” of America, who wrote the doctrine of the separation of legislative and executive powers into the constitution. As a result, neither the president nor cabinet officials are members of the legislature, and nor can they be removed from office by a legislative majority. At the same time, the legislature controls the budget and the government’s ability to borrow. The potential for an impasse is evident.

The shutdown and debt ceiling are separate issues, but the shutdown is raising fears over the debt ceiling. America has a legal limit on its borrowing of $16.7tn, and it’s likely to hit that point in mid-October. If a deal isn’t reached, the US would run out of borrowing room, meaning the world’s biggest economy would default on its debts.

The first-ever default could trigger a massive drop in global stock markets, push up borrowing costs sharply and cause businesses to stop hiring and consumers to stop spending. It could have catastrophic consequences for the world, the International Monetary Fund warned yesterday.

Does it mean the Republicans, who want to extract concessions on Obama’s signature healthcare reform, have turned debt-unfriendly all of a sudden? Not really.

The last Republican presidential candidate, Mitt Romney, and his vice-presidential running mate, Paul Ryan, campaigned in 2012 on a programme that would likely have added trillions of dollars to the US debt over the next 10 years. So the debate is all about politics.

The partial shutdown of the US government over the budget is seen not having an immediate impact on Gulf economies. But things could be different if there is a default. “Rating agencies would downgrade US credit ratings in the event of default; oil prices will decline if there is slower growth in the US, which would adversely affect fiscal and external balances in regional economies,” said Giyas Gokkent, group chief economist at National Bank of Abu Dhabi.

During the 2011 fight that skirted default by a day or two, S&P stripped the US of its coveted AAA credit rating. The episode cost the Treasury $1.3bn in higher interest costs that year.

True, the shutdown and the threat of a default is ultimately a product of the US democratic system. But its impact is no longer a domestic concern with the US still being the hub of a highly globalised economic system. Consider the serious damage done in emerging economies from the Federal Reserve’s premature talk of “tapering” its stimulus programme.

If the world catches a cold when America sneezes, US lawmakers would better reach an early deal to prevent it from worsening into an acute infection that would require stronger medication for cure.