With only a few days before the August 2nd deadline, any clear agreement on raising the U.S. debt ceiling is still not in sight. Both the Democrats and Republicans appear to be parked in their respective political corners, with the only thing they can seem to agree on is that they are deadlocked.
After all the sound and fury of the past few months around the debt ceiling, it is hard to imagine it was introduced less than a century ago as a mechanism to simplify sovereign borrowing. Article I Section 8 of the United States Constitution gives Congress the sole power to borrow money, and Congress used to have to authorize every single debt issuance. As a workaround to this cumbersome process, they created the debt ceiling, as we know it, by the Second Liberty Bond Act in 1917.
The U.S. debt has become a ferocious beast with an insatiable appetite. In 2010, mandatory spending grew nearly 15 percent over the previous year and totaled $2.17 trillion. Interest on the national debt– also a mandatory expenditure – cost American taxpayers $164 billion that year. Discretionary spending was also up significantly in 2010, increasing almost 14 percent over the previous year to $1.38 trillion.
The United States has not been able to curb its spending, nor to find a way to offset its deficit with additional revenue. The political agenda makes tax increases a tough proposition to sell, especially so close to a presidential election year.
Foreign investors hold half of the U.S. debt â€â€the majority is held by the Central Banks of China, Japan and the United Kingdom. If the U.S. is not able to increase the debt ceiling, these foreign bondholders will continue to be paid because the U.S. Treasury can easily cover their interest payments. However, other payments will need to be prioritized and there will be political implications. Very few politicians will want to be perceived by the voting public as paying foreign bondholders ahead of American service men and women.
Even if a last-minute agreement is reached, Standard and Poor’s has signaled that it may downgrade the U.S. credit rating anyway. These recent events could well mark the beginning of the end for an over-abundance of AAA debt, and this would change the face of global finance. Up until now, U.S. debt has for all intents and purposes been considered “risk-free”â€â€after 2001, and even after the 2008 economic crisis.
There is a back and forth tennis match going on across the Atlantic between the U.S. Dollar and the euro, and the foreign exchange markets are watching. The pending Greek default and social unrest puts downward pressure on the euro, but this volley across the pond is met by the solid backhand of a veto threat by the U.S. president on the next Republican proposal. EUR/USD volatility is leading the way in a skittish currency market.
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Related: Greek Economic Crisis Infographic
