Wednesday, 25 September 2013

US debt negotiations: Debt before dishonour...

The US Senate is expected to vote today on a short term continuing resolution to fund the Federal government until December this year. The bill was advanced by the Republican controlled House of Representatives to fund the government, but without the Affordable Care Act. Known as "Obamacare", this represents the major legislative achievement of President Obama’s tenure in the White House.  Although Obamacare would have been passed into law, it would be irrelevant without Congress appropriating funds for it to be implemented.

Everybody expects the Senate to return the bill with the Obamacare section removed, and ultimately this bill will probably be passed with no lasting damage to President Obama's legislative legacy.   But even so this may well just be a prelude to a fight over the Federal debt ceiling in mid-October.

The debt ceiling is a statutory limit on the amount of money the US government is allowed to borrow.  It means that the President and his cabinet, the executive branch of government who must execute the laws passed by Congress, also need funds to be appropriated for them by Congress and even once those appropriations have been made they may need Congress's permission to borrow the money.

There have been a number of instances of the government running out of appropriated money. It happened twice under the Clinton government and once in the fictional world of West Wing. In those instances it made compelling viewing and did not have catastrophic consequences. Failure to raise the debt ceiling, by contrast, makes it impossible to maintain payments on Treasuries which therefore constitutes a default of sorts and, by the reckoning of some, means a Lehman Brothers-style financial event. Historically, investors have been bad at predicting these kind of consequences.

As in the 1995 and 1996 shutdowns, the eventual victor is likely to be driven by the spin parties are able to put on events.  On balance, public opinion is against the idea of raising the debt ceiling but is also against the de-funding of Obamacare.

With the US recovery strengthening and unemployment dropping any fiscal fireworks at this stage could be spun as having damaged the recovery. Back in 2011, when the last serious debt ceiling challenge was mounted, unemployment was 9% and the budget deficit was worsening.  Now joblessness has fallen to 7.3% and the deficit is shrinking. In just over a year the mid-term elections will give the US public another chance to decide who controls the critical House of Representatives. Republicans and Democrats will have to choose their moves carefully.

Guy Foster
Head of Portfolio Strategy

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