A unique clause within America’s constitution imposes a federal public debt ceiling that can only be changed by the Congress.
Over the past few years (see chart attached) the US debt ceiling has been ratcheted up on a regular basis. The current debt ceiling, which sits at $14.3 trillion, was reached on 16 May. Strangely, the government is currently meeting its financial obligations through a number of accounting tricks, including suspending investments in retirement funds. The scope to use such tricks will run out on 2 August, after which time the government will be technically unable to meet its obligations.
Agreeing to raise the debt ceiling should be straightforward and has happened many times in the past. And refusing to allow an increase will ensure the very fiscal crisis that politicians say they want to avoid.
Instead, the delay is politically motivated, with the Republicans seeing an opportunity to extract more spending cuts from the Democrats, similar to the fight about the 2011 budget, which threatened to shut down government earlier this year.
Unfortunately, despite months of negotiations, the two sides remain at odds on fundamental fiscal policy issues. And although an agreement is still likely, the most recent talks between the two parties have become less encouraging.
This stalemate in talks around raising the debt ceiling has resulted in the major credit rating agencies warning that they could downgrade the US. Currently all the rating agencies give the US a AAA rating.
In fact, the US has never not had a AAA rating (see our email dated 18 April 2011), but this could change, considering that Standard & Poor's has placed its US 'AAA' long-term and 'A-1+' short-term sovereign credit ratings on CreditWatch, with negative implications. Standard & Poor's uses CreditWatch to indicate a substantial likelihood of it taking a rating action within the next 90 days, or in response to events presenting significant uncertainty to the creditworthiness of an issuer.
According to S&P, there is at least a one-in-two likelihood that they could lower the long-term rating on the US within the next 90 days. If that occurs, the rating could drop by one or more notches into the 'AA' category. This would also apply if S&P conclude that future adjustments to the debt ceiling are likely to be the subject of political turmoil to the extent that questions persist about Congress' and the Administration's willingness and ability to timely honour the US's scheduled debt obligations.
Overall, while it is probably fair to conclude that the risk of an actual payment default on US government debt obligations as a result of not raising the debt ceiling is small, it is also reasonable to conclude that the risks are rising and that a default would be extremely unwelcome in the current climate of extreme financial uncertainty in southern Europe.
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