US Debt Crisis - 2011

Hello friends,

Its been a while I have not written anything here. Today, I was discussing about "US Debt Crisis" with one of my friend. It's most discussed topic now a days, specially in a financial world. I have been going through various news articles , blogs on this topic. So thought of sharing the info -

The first questions came in mind, why Aug 2?

According to the U.S. Treasury Department, “Tax receipts for June and July are not more than expected. So U.S. will exhaust borrowing authority on Aug 2nd and after that date there is no way to guarantee we will be able to meet all of the nation’s obligations”. Few investment bank’s analysts are predicting that the end date is not 2nd but 10 Aug (as per Barcap), Sep 9 ( as per Nomura) . But still it’s not that far.

Currently, total public dept is $14.29 trillion; just $25 million shy of the debt limit. The U.S. has $87 billion of maturing debt next week. So to avoid default on bond obligations, Republicans and Democrats are trying to reach an agreement to raise the $14.3 trillion borrowing ceiling and to reduce future annual deficits.
What would happen if there is no decision on raising borrowing ceiling by Aug 2? I was reading one interesting blog, he has mentioned below points for my above question.

• Interest rates in U.S. will start to rise and continue for some time. Remember, the Federal Funds rate was over 20% in June 1981.
• The housing market will start a double collapse due to a rapid rise in mortgage interest rates.
• In the uncertain environment, housing sales will stall and the terrifying housing data in September, October and November 2011 will have a knock on effect i.e. home sales will completely stall.
• This will precipitate what should have occurred in 2008 and 2009 had the banks not been bailed out. The assets underlying many of their creative financial products will drop massively in value causing many banks to fail, this time without a bailout.
• Because the dollar is the world’s reserve currency and many countries are holding Dollars, US debt and dollar denominated debt, a world financial crisis of epic proportions will begin to unfold.
• If ratings agencies actually downgrade US debt, the effect will be catastrophic. Many banks, countries and other organizations are required to keep a specific mix of risk on their balance sheets. This will force world-wide balance sheet restructuring as countries and companies move away from the US dollar or dollar denominated debt – specifically US government debt.
• The dollar will increase the rate of it’s current slide.
• Gold prices will hit $1800 in September/October and $2200 or more by year end.
• Credit will once again dry up wreaking havoc among businesses and banks.
• Expect massive layoffs world wide as businesses deal with lack of access to credit and batten down the hatches preparing to weather the storm.

So what good will come of this?

• With a declining dollar, US exports will earn more money.
• There will be a massive power restructuring in corporate America as incumbents fail by the hundreds, opening up opportunities for young, innovative businesses.
• Some wealth will be transferred back from the wealthy holding US dollars to the true innovators in this country as the dollar declines and the value of exports increase.
• Manufacturing jobs will return to the USA as it becomes cost effective for other countries to use local labor force and base operations in the USA.
• US politicians will be exposed as incompetent and old power bases and old boy networks will crumble giving way to new blood, new ideology and possibly a new political party in the United States.

What's view of "Standard & Poor's" on this?

Failure to pay off maturing debt or missing interest payments (approximately $62 billion of interest is payable on Aug. 15) would constitute a selective default pursuant to our criteria, and Standard & Poor's expects it would lower the sovereign rating to 'SD'. Even if the Fed and other central banks managed to keep the financial system functioning, we expect that markets around the world would be severely damaged. In such a hypothetical scenario, we expect that equity markets would generally plunge, borrowing costs and interbank lending rates would soar, and corporate credit markets would be closed to all but the highest quality issuers. We envisage that consumers and businesses would likely stop spending on all but essential items, and the value of the dollar would drop by 10% or more against other major currencies. With the dollar heading lower, investors would likely look for hard assets like oil and other commodities, driving prices higher.

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-Raju