US govt reduced to live on borrowed time

3D chrome Dollar symbolVivek Kaul

Governments spend more money than they earn and finance the difference through borrowing. The government of United States(US) is no different on this front. The trouble is that it cannot borrow beyond a certain limit. This limit, known as the debt ceiling, was set at $16.69 trillion.
This ceiling should have been breached in May 2013, a little earlier this year. Since then, Jack Lew, the American treasury secretary, has taken a number of extraordinary measures like delaying public employee pension fund payments, in order to ensure that the government expenditure remains under control. Lesser expenditure meant lesser borrowing and hence, the government managed to keep its total borrowing below $16.69 trillion.
Today i.e. October 17, 2013, the government would have run out of the extraordinary measures that it has been taking. Given this, the treasury department would have exhausted its borrowing authority.
Hours before this would have happened, the leaders of the Democratic Party and the Republican Party in the American Senate stuck a deal, suspending the debt ceiling. This will allow the US government to borrow beyond $16.69 trillion, till February 7, next year. The will also end the current government shut-down in the US and keep the government running along till January 15, 2014.
This is not the first time that the US government came close to its borrowing limit, given that the debt ceiling has been in place since 1939. Since 1960, the debt ceiling has been raised 78 times by the American Congress. But this time around the Democrats and the Republicans left it too late, each waiting for the other to blink first.
If the ceiling had not been extended the short-term repercussions would have been terrible. The treasury secretary Lew had said in early October that the US government “will be left…with only approximately $30bn” come October 17. This would not be enough to meet the expenditure of the government, which can be as high as $60 billion on some days, Lew had pointed out.
Interest payments of around $6 billion are due on US government bonds before the end of this month. Along with that, bonds worth between $90 to $93 billion need to be repaid between October 24 and October 31 (Source: www.thefinancialist.com) Governments issue bonds to borrow money.
The US government has reached a stage wherein it does not earn enough to repay the money it has already borrowed by issuing bonds. Hence, it has borrow more money by issuing fresh bonds to pay off the older bonds. If the debt ceiling had not been extended, it would have become very difficult for the US government to repay the money it had already borrowed.
More importantly, the US government bonds are deemed to be the safest financial security in the world. If the US government defaulted on paying interest on its bonds or repaying the principal, there would have been mayhem in financial markets, all over the world, including India. It has even been suggested that the crisis that could have unfolded would have been bigger than the crisis that followed the bankruptcy of Lehman Brothers in September 2008. Investors would have sold out of US government bonds driving up global interest rates.
The US government would also have had to prioritise its expenditure. Does it make pension payments? Does it pay its employees and contractors? Does it pay interest on its bonds? Does it repay maturing bonds? These are the questions it would have had to address. Also, there are no legal provisions guiding the government on who to pay first. Hence, any prioritisation of payments could have led to a slew of lawsuits against the US government.
Given the negative repercussions of the debt ceiling not being extended, the markets were positive that a deal reached would be reached. Stock and bond markets around the world have been stable. And gold, looked at as a safe haven, is quoting at levels of around $1280 per ounce (one troy ounce equals 31.1grams).
The trouble is that the US government will cross its debt ceiling level again in February, 2014. What happens then? How long can the American Congress keep increasing the debt ceiling? The basic problem is that the US government has borrowed too much money, and continues to do so, and if it doesn’t default today, it will default in the years to come.

The article originally appeared in the Daily News and Analysis dated October 17, 2013

(Vivek Kaul is the author of Easy Money. He can be reached at vivek.kaul@gmail.com

Advertisements

About vivekkaul
Vivek Kaul is a writer who has worked at senior positions with the Daily News and Analysis(DNA) and The Economic Times, in the past. He is the author of the Easy Money trilogy. Easy Money: The Greatest Ponzi Scheme Ever and How It Is Set to Destroy the Global Financial System , the latest book in the trilogy has just been published. The first two books in the trilogy were published in November 2013 and July 2014 respectively. Both the books were bestsellers on Amazon.com and Amazon.in. Currently he works as an economic commentator and writes regular columns for www.firstpost.com. He is also the India editor of The Daily Reckoning newsletter published by www.equitymaster.com. His writing has appeared across various other publications in India. These include The Times of India, Business Standard,Business Today, Business World, The Hindu, The Hindu Business Line, Indian Management, The Asian Age, Deccan Chronicle, Forbes India, Mutual Fund Insight, The Free Press Journal, Quartz.com, DailyO.in, Business World, Huffington Post and Wealth Insight. In the past he has also been a regular columnist for www.rediff.com. He has lectured at IIM Bangalore, IIM Indore, TA PAI Institute of Management and the Alliance University (Bangalore). He has also taught a course titled Indian Economy to the PGPMX batch of IIM Indore. His areas of interest are the intersection between politics and economics, the international financial crisis, personal finance, marketing and branding, and anything to do with cinema and music. He can be reached at vivek.kaul@gmail.com

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: