US debt default - political or financial nuclear weapon?

Wilberne Persaud, financial Gleaner COLUMNIST

Superlatives always present a problem. Judgements they are and, as a result, subject to contesting views.

This one, however, may not be: the most important and potentially harrowing news item surrounds impending default on US government debt. Here's another superlative: stability of our global financial system depends critically on the 'full faith and credit' of the US government.

Fitch Ratings, the third-largest of the major debt-rating agencies after Standard & Poor's and Moody's Investors Service, took the first tentative step Tuesday towards lowering the US' AAA debt rating.

Fitch did this in light of the October 17 fast-approaching deadline for raising the US debt ceiling at the risk of default. You read this on Friday, October 18, so as we write, the future is, as always, unknown.

Fact, though, is that most decisions we make are made with incomplete information - many unknowns. In financial markets this dilemma is particularly severe. The reason is obvious: expectations play a vital role.

Boiled down to its essentials, the 'full faith and credit' of the US government up until this moment, is something that reduces the number of unknowns.

More valued than cash

US Treasuries are often, believe it or not, more valued than cash. So even as Fitch expresses its opinion that it believes the debt limit will be raised before default deadline, it placed these 'solid-as-a-rock' US Treasury bonds on 'rating watch negative', a hint that downgrade is possible, even though perhaps unlikely.

In their view, breaching the debt ceiling deadline would leave the US Treasury Department, as its emergency measures run out on Thursday, with little capacity to honour payments on the country's US$16.7-trillion national debt.

The Tea Party wing of the Republican Party, much as it tries to disown fractious behaviours leading to this crisis and make ridiculous claims about the impact of debt default, is on a path to truly horrible consequences for the US and world economy. What are some of these claims?

Let's start with the infantile and ridiculous. Republican Ted Yoho of Florida told The New York Times that default would be good for the US and, indeed, for the world economy. He actually says, "I think we need to have that moment where we realise [we're] going broke. I think, personally, it would bring stability to the world markets".

Others claim it shall not happen; the notion of default is 'nonsense' and economists often make wrong predictions.

Finally, some claim the US Treasury could discriminate amongst obligations in making payments - like paying interest on Chinese trillion-dollar Treasuries holdings before making social security or private-sector military contractors' payments.

Automated payments system

Apart from questionable constitutional legality of any such operation, the sheer madness of attempting - within a 24-hour time frame - to tamper with a computerised, automated payments system that handles hundreds of thousands of transactions daily is hard to fathom. And yes, it must be a 24-hour time frame because no such eventuality was ever contemplated. No Plan B software in the vault!

No doubt, many of us remember the fallout attending the Lehman Brothers collapse of September 2008 and the greatest recession it precipitated. A US debt default would have worse consequences that some feel could last for a generation. Immediately, US government borrowing costs would escalate. A half of a per cent increase in such rates would trigger interest costs rising to the tune of billions annually - tax revenues the Tea Party abhors and would never agree to increase, would go a shorter distance; they would filter through the system to mortgages and student debt in the US.

With the 'full faith and credit' of the US government tanked, uncertainty and turmoil in financial markets is an easy-to-see picture.

Warren Buffett doesn't "think it will happen, but if it does happen, it's a pure act of idiocy". He, like so many others, believes the US two-party system should come to an agreement never to use the debt limit as a bargaining chip because it is "a political weapon of mass destruction".

Fact of the matter, however, is that most political analysts believe such a pragmatic agreement is most unlikely. All we can do? Wait with bated breath, and see.

EDITOR'S NOTE: The US Congress voted late Wednesday night to reopen the government until January 15 and raise the debt limit until February 7, 2014.

Wilberne Persaud, an economist, currently works on impacts of technology change on business and society, including capital solutions for innovative Caribbean SMEs.Email: wilbe65@yahoo.com