Last week I published a short article on the effects of the
Government Shutdown. Today I’ll explain what will happen on Thursday 17th
October if congress does not raise the United States of America’s debt ceiling.
Like many other countries (including Malta) the US collects
less money than it spends. This has been happening for many years. The US
government’s main source of income is federal taxes while its spectrum of spending
is wide. Food stamps, Medicaid, the military and the 2.65 million who are
employed by the federal government are examples of where income tax money is
distributed internally. The US also pays out billions in financial aid to
counties such as Egypt, Israel, Pakistan, Mexico, Nigeria, the Philippines and
another 25 countries for “good behaviour”, “good friendship” or military bases.
The US is a major contributor to the United Nations, NATO and other
international bodies.
Being the most indebted country in the world, the US pays a
lot of money in interest on its debt. According to the US Treasury website (http://www.treasurydirect.gov/govt/reports/ir/ir_expense.htm)
more than $415 billion was paid in interest between September 2012 and October
2013.
In order for the government to borrow more money it needs
the approval of congress. If congress does not approve this increase the
government will run out of money.
Let us imagine that the US government is a person. This person
has a family to support. He has a wallet, a bank account, a credit card and a loan.
The bank accounts stand at zero, the credit cards are maxed out and a loan
payment is due. His wallet is bone dry. This person has a job but the pay
cheque will not cover the expenses.
Now think of congress as the Bank that can approve an
increase in this person’s loan facilities. If the loan ceiling is increased the
person can cover the additional expenses. If not, …
If the US were to default, the financial markets will
probably react very badly and we could risk facing another Black day in which
stock exchanges spiral out of control as investors see this uncertainty as a
sign to pull out of certain markets. Another effect of a default would probably
be that rating agencies downgrade the US. This will result in an increase in borrowing
costs. Simply put, instead of paying $415 billion in interest the government
would have to pay $800 billion for the same amount of money. This is because
investors no longer see the US government as a safe place to invest their money
and will demand more interest. It is like having negative notches on your
credit rating. Once this happens banks will no longer want to loan money and you
would have to go to a pay-day lender or, even worse, a loan shark.
A default would
result in a weaker dollar. Since most international business is conducted in
this currency, countries who already committed to transact in this currency
will suffer because of this unexpected change.
Hopefully the President and Congress see sense before damage
is done.
