Damage from debt default may be irrevocable: Geithner

[Musicwhiz]

America is borrowing its way into big trouble!

May 16, 2011
Damage from debt default may be irrevocable: Geithner

US Treasury Secretary Timothy Geithner

WASHINGTON: With the United States government about to hit its US$14.3 trillion (S$18 trillion) debt limit, Treasury Secretary Timothy Geithner has warned of 'catastrophic' consequences and a new recession if Washington is not able to borrow more.

A divided Congress has run out of time to raise the debt limit before today's deadline, forcing Mr Geithner into an emergency reallocation of funds so the government can meet its obligations, including payments to US Treasury bond-holders.

Those measures are expected to give the government only until Aug 2 before it will start defaulting on payments including those on Treasury debt, an event that could trigger chaos in world financial markets.

'This would be an unprecedented event in American history. A default would inflict catastrophic, far-reaching damage on our nation's economy, significantly reducing growth and increasing unemployment,' Mr Geithner said, in a letter last Friday, to Democratic Senator Michael Bennet.

The Obama administration and lawmakers are battling over how to curb the mounting US debt, with Republicans refusing to increase the debt limit without deep spending cuts.

Senate Minority Leader Mitch McConnell, a Kentucky Republican, said last Thursday he wants 'significant' near-term cuts in federal agency budgets paired with longer-term reductions to programmes like Medicare and Medicaid in exchange for his support for an increase in the debt limit.

In some of his most stark language to lawmakers so far, Mr Geithner said a default or missed payments would not only increase borrowing costs for the US government but also for average Americans, businesses and local governments.

'An increase in Treasury rates would make it more costly for a family to buy a home, purchase a car or send a child to college,' he said.

'It would make it more expensive for an entrepreneur to borrow money to start a new business or invest in new products and equipment.'

The world's biggest economy is recovering only gradually after the 2007-09 financial crisis but some 13.7 million Americans are out of work and higher petrol and food prices are threatening to slow the recovery.

If Congress does not increase the borrowing cap by August, Mr Geithner will be forced to start choosing which payments to make first.

Missing or delaying payments on a host of obligations, including those to businesses for goods and services and bond payments to investors, would result in a massive and abrupt cut in federal spending and aggregate demand, the letter warned.

'The abrupt contraction would likely push us into a double-dip recession,' Mr Geithner said.

The US government bond market has so far remained calm about the risk of a default.

But Mr Geithner and Federal Reserve chairman Ben Bernanke have repeatedly urged Congress to act quickly to raise the debt limit.

'Even a short-term default could cause irrevocable damage to the American economy,' Mr Geithner noted, in response to a letter from Mr Bennet requesting an estimate of the consequences of failing to increase the limit.

Mr Geithner pointed out that raising the debt ceiling does not authorise new spending commitments.

'It simply allows the government to finance existing legal obligations that Congresses and presidents of both parties have made in the past.'

In response to Mr Geithner's letter, Mr Bennet said it was 'absolutely urgent and essential' that lawmakers draft a plan that 'materially reduces the deficit'.

'Playing politics with the debt limit would rattle the capital markets, blow an even bigger hole in our deficit and would likely throw our economy into another deep recession,' he said in an e-mailed statement.

The US government is borrowing approximately US$125 billion per month.

As of last Thursday, the country was US$38 billion below the debt ceiling.

REUTERS, BLOOMBERG

'This would be an unprecedented event in American history. A default would inflict catastrophic, far-reaching damage on our nation's economy, significantly reducing growth and increasing unemployment.' US Treasury Secretary Timothy Geithner

[tanjm]

Just posturing by politicians. The US would never go into default (at least not this way). One side wants to force the other to agree on spending cuts.

Sovereign countries effectively "go into default" via currency depreciation.

[hongonn]

Should we start getting worried about US will start defaulting their debt? Seem like the market is unfazed by the news, still sustain very well.

Debt limit reached, US halts 2 pension investments
US hits debt limit, Geithner suspends investments in 2 big government employee pension funds
Martin Crutsinger, AP Economics Writer, On Monday May 16, 2011, 12:39 pm EDT

WASHINGTON (AP) -- Treasury Secretary Timothy Geithner said Monday that he will immediately halt investments in two big government pension plans so the government can continue to borrow money.

Geithner informed Congress of his decision in a letter stating that the government had officially reached its $14.3 trillion borrowing limit. He repeated a warning that if lawmakers do not increase the borrowing limit by August 2, the government is at risk of an unprecedented default on its debt.

[Nick]

The phrase coined by Donald Trump (not verified) would aptly describe the current situation:

If you owe the bank a million dollars, the bank owns you but if you owe the bank a billion dollars, you own the bank.

[tanjm]

Not even mentioned by marketwatch. http://www.marketwatch.com/

[piggo]

The phrase coined by Donald Trump (not verified) would aptly describe the current situation:

If you owe the bank a million dollars, the bank owns you but if you owe the bank a billion dollars, you own the bank.

"If you owe your bank a hundred pounds, you have a problem. But if you owe a million, it has."

http://en.wikiquote.org/wiki/John_Maynard_Keynes

Just that now it's a few trillion... just hope they don't run out of trees to print the stuff

[Jared Seah]

That's the danger of over-reliant on Governments to take care of us - be it pensions or CPF. The politicians who made promises to us may not be around in 30 years time to be accountable....... US budget deficit is not something new - just the scale. No US citizens complained when US was cutting taxes even when there's no reserves in the early 90s.......

It's a reason why I've always respect Hong Kongers. They have very little social safety net compared to most countries; but the resilience they've built up is something other citizens living in green or glass houses can't compete!

[hongonn]

Is something brewing on the way? Many argue that US can't avoid default its debt forever.

Buffett’s silly talk about the U.S. debt
Commentary: U.S. isn’t special and can’t avoid default forever
By Barry Wood

WASHINGTON — At Berkshire Hathaway’s annual meeting in Omaha, Chairman Warren Buffett raised more than a few eyebrows when he said that, “The United States is not going to have a debt crisis as long as we keep issuing our debts in our own currency. The only thing we have to worry about is the printing press and inflation.”

Was the oracle really suggesting that there is no chance that the U.S. will ever experience a Greek-style debt meltdown where it couldn’t get financed and would have to turn to outsiders like the International Monetary Fund for help? Apparently, he was.

Harvard University historian Niall Ferguson, who has written extensively on debt, is aghast at what he calls Buffett’s highly simplistic view. “Buffett,” he says, “must know this is nonsense.” Ferguson continues, “Britain had complete monetary sovereignty in the mid-1970s and yet the IMF had to be called in. I could give numerous other examples. And then there is the inflation risk, which is implicit in his statement. We won’t have a debt crisis because we can print unlimited quantities of paper dollars. If that’s the good news, I don’t want to hear the bad.”

Other experts are similarly amazed by Buffett’s assertion. Carnegie Mellon business school professor Allan Meltzer, a pre-eminent scholar of monetary policy, agrees that having the world’s reserve currency gives the U.S. a huge advantage when issuing debt. But Meltzer adds, “We can have a crisis if the Chinese or Japanese start selling their mountains of dollar debt, or if the dollar collapses instead of declining, and if we get a big inflation.”

Desmond Lachman of the conservative American Enterprise Institute says Buffett is being disingenuous if he thinks debt won’t get the U.S. into deep trouble. “If the markets think that the U.S. public debt situation is out of control,” he says, “and that the Fed is going to print money to inflate the U.S. out of its debt problems, blood will be spilt in the bond market as people dump Treasuries until interest rates rise very high to compensate them for the inflation risk. That will be disastrous for the stock market and for the U.S. economy.”

To be fair, Buffett’s comment did specifically mention the possibility of inflating away debt by repaying bond holders with cheaper dollars, but since that implies high inflation, high interest rates and a collapsing dollar, doesn’t that in itself constitute a debt crisis?

Institute of International Finance chief economist Phil Suttle says it is all a matter a confidence. “If bondholders lose confidence in a country’s economic policies,” he says, “there will be a crisis, but the exact shape of it can vary. But it is a big myth to say it can’t happen here.”

Carmen Reinhart of the Peterson Institute for International Economics and co-author of a monumental study of debt (“This Time It’s Different”), says with gross public debt now equal to 94% of gross domestic product, the U.S. has become vulnerable to a crisis. She says the buildup of U.S. debt is unprecedented and that the necessary deleveraging has not yet begun. She warns policy makers “to expect the unexpected.”

The problem is that with debt exceeding $14 trillion and growing by $1 trillion annually, interest payments could rise from the current 1% of GDP to 13% within 20 years. Historically that kind of heavy debt burden results in a combination of anemic economic growth, high inflation and high interest rates. Billionaire philanthropist Pete Peterson, a long-time crusader on the issue, calls debt “the transcendent threat to the country.”

Is there a debt reckoning ahead? Former Sen. Alan Simpson, who co-chaired the bipartisan debt commission that last November recommended a set of spending cuts and tax increases to the president, says yes. Addressing an audience earlier this year, Simpson said a debt crisis could strike suddenly. “It won’t be the old slippery slope crap that we read about,” he said. “It’ll be very swift and very dramatic, like in Greece or Ireland or Portugal or Spain or wherever. I don’t know where this is going, but I tell you, it won’t take long.”

Economist Laurence Kotlikoff of Boston University believes Buffett is in denial. “On the face of it,” he says, “his statement is true right up to the point that it’s not. That is to say, we have some capacity to borrow, but it is not unlimited and the market will shortly make that clear, in my opinion.”

Sebastian Mallaby of the Council on Foreign Relations agrees that an eventual debt crisis is likely unless Congress and the administration agree on a substantive program of deficit reduction. Writing in the May 9 issue of Time magazine, Mallaby says the situation could deteriorate rapidly if China simply stops buying U.S. debt at its customary pace. If other players in the bond market thought, “Treasury prices were headed downward... every gunslinger on Wall Street would shoot his way toward the exit.” The result, he says, would be skyrocketing government borrowing costs, a plummeting dollar, and “cardiac arrest in the heart of the economy.”

With the debt stakes so high, Warren Buffett owes it to his legion of admirers and the public at large to explain more fully what he means in saying categorically, “the U.S. is not going to have a debt crisis.”

[natnavi]

My 2 cents worth.

Geithner is just playing with politics to get the Republicans to concede.

USA has lots more to gain if she prints more money.
Print more money ---> Dollar devalues ---> Boosts Export ---> Gain competitve edge against the Chinese.

The US has always been trying to get the Chinese to appreciate her Yuan so that the playing field will be "level". However the Chinese has been unwilling. If the Chinese will not do it, why not I do the reverse and devalue my own currency to make the field more level. The Chinese will eventually have to concede.

The best part about this plan is that there is virtually no consequence in doing so. I find it hard to believe that the Chinese will want their biggest customer to go bankrupt.

[sgd]

Let's just think for a moment here about the repercussions say if the dollar crashes and people lose faith in treasuries until they start paying sky high interests. I remember there was a discussion thread on this.

My view is If they really start dumping treasuries and it causes a run on the US bond market it's time to start praying hard. The size of global bond market is 82 trillion dollars, 31 trillion of that consists the size of US bond market. http://en.wikipedia.org/wiki/Bond_market

If we have a run on the US bond market it will melt every stock exchange in the world.

Our national reserves how much is GIC exposed to? And what about China and Japan they hold a combined 2 trillion worth of treasuries that will potentially become 200 tons of toilet paper.

And since many banks also hold treasury securities it may also cause a run on the banks.

If you invested in property I think it will at least be a good hedge against inflation but the outstanding loans that are tied to it could be vulnerable if they start hiking up rates. And since people could be tightening their belts by this time it may not be a sellers market anymore even though property prices could be high and anybody left with any real money will be looking for distressed assets at fire sale prices instead.

It will be a severe credit crunch and usher in the dark days. There could be many social problems in many countries if people lose their savings overnight just like what happened in iceland

Of course for now this stark scenario is just my imagination running wild