What is the topic all about ?
•US government is
having a high fiscal deficit, which means its earnings (through taxes) are less
than the expenses (spending).
•So, in order to fill
the gap between the two, US government have been borrowing since last few
decades, as their spending is higher than income.
•So, how much can US
government borrow ?
•They can maximum
borrow up to the limit fixed by the US Congress government- which is the
combination of two parties- Republicans and Democrats
•The first borrowing
limit was enacted in 1917.
•Since 1962, Congress
has raised the borrowing limit 77 times. It now stands at 16.7 Trillion $
•This means that if US
borrows now, maximum it can borrow is 16.7 trillion dollars.
What’s the problem then ?
•The 16.7 trillion
dollars of US DEBT limit which was decided by government got hit on May 19,
2013.
•This means now no
more US government can borrow money from markets and use it to fuel deficit.
•So from May 2013 till
now, US government is trying to run through the deficit by doing whatever it
can but time has come that now US will have to increase the debt limit to
borrow or else it will default on its interest obligations or would have to cut
on its spending
•So money needs to be
borrowed more by issuing US Treasury bills in market and raise more funds, but
as we said now the limit is over and US government is not allowed to raise any
more funds through Treasury bills.
Why US Debt limit cannot be increased more ?
•Now it’s a good
question that US government have been increasing its debt limit time and again,
and was able to show everyone that it is managing things well, and not going to
default, so why not US increase the limits again?
•Problems are
politically connected so lets understand what it is all about:
•US Congress has 2
parties which votes for all important decisions –
A) REPUBLICANS and B) DEMOCRATS
•Barack Obama who leads America is from Democrats, and Democrats are known to be very liberal in policies and this we can see by lavish spending by US government and which have lead to consecutive increase in debt limits.
•On the other hand
Republicans are more conservatives and want to focus on reducing spending and
increasing taxes, so that America can reduce its deficit.
•So in 2011,
Republicans were not supporting the increase in US debt ceiling limits as this
was making US deficit vulnerable, but Democrats managed to sort the issue with
Republicans by telling them that they will reduce spending and increase taxes
later on, and for this Democrats asked to increase debt limit more by 2.4
trillion dollars
•This 2.4 trillion
dollars in Aug 2011, made sure at least US will not have any problems till
coming 2 years, and we saw S&P downgrading US Treasury just after this
increase in 2.4 trillion dollar limit, because of chances of defaults going
ahead.
•So, the limit got
over in Feb 2013, when the US debt limit got finished at 16.4 trillion dollars,
however three months extension was provided during which the debt rose to 16.7
trillion dollars.
•Hence this became the
new limit in a deal that Congress finalized in May 2013.
•Since May 2013, debt
limits have not been increased because of Republicans not agreeing to increase
in debt limit and they want Democrats to cut spending and increase taxes.
Why
Democrats are not willing to cut spending and increase taxes is that election
year is coming, and VOTES are
important.
What's the Current Status ???
•Since
the Debt limit is not increased after May 2013 and even Democrats are not
willing to increase taxes and cut spending, the government is having a SHUTDOWN
•In
a letter written by Treasury secretary of US, he said that if the debt ceiling
is not raised by 17th October, US government will not be able to pay for US
Treasury interest to bond holders, government contractors and social security
recipients.
•It
is said that after 17th October 2013, US government would not be able to
finance its debt and it would be able to do it with remaining cash in hand –
approx 30 billion dollars and some tax inflows.
•But,
this can only suffice up to few days and between 22 October and 31st
October, this would also finish.
What next ?
•Markets went up last
week thinking as 17th October is coming near,
US would do something to increase the debt limits, as US cannot default
(Assumption)
•However, if the US Congress
is not able to increase the debt limits, then in coming months, it would face
lot of problems in paying the interest on US Treasury it have issued to raise
funds, and also to US citizens who are supposed to be given benefits of pensions,
and federal government employees salaries, medical pensions etc.
•Default would occur
if US do not pays its treasury holders interest. (China, Japan and other
foreign countries together are holding 34% of total US Treasury debt)
•Therefore US will try
and pay the Treasury holders first and later on pay the US citizens on their
benefits.
•But how can this
happen ?
•This can be done in 2
ways, either not pay US citizens and only pay Interest on US Treasuries by
remaining money US government has, to avoid Default on payments to outsiders
•Or
•Increase the debt
limits and pay everyone their dues
•But, the first way of
only paying US Treasury holders and not others is not possible.
•Why? Because all the
payments are through electronic computer system, and there is no option where
US can feed in to machine that pay only few and don’t pay others. So anyhow US
will have to make sure money is there in the Computer system, or else defaults
is sure.
•So this means, DEBT
Ceiling limit most probably would be increased as US don’t have any other
option, and this would lead to Equity markets moving up sentimentally.
•If the US defaults on
Treasury bonds interest, we can assume a global financial market crises, as US
itself will have to bear higher borrowing costs, as if US don't pay interest on
bonds, it would lead to selling in bonds, and resulting in higher borrowing
costs for corporate.
Conclusion:
•What happens when you borrow money ? You have to pay
interest ? What if you don’t have money to pay interest ? You borrow more and
pay Interest ! What if now no one allows you to borrow more ? YOU DEFAULT…….!
•So, we expect US Debt ceiling to increase in coming
weeks, or else how will US pay for its interest ? This should bring cheer to
equity markets !
•That was all about US debt ceiling crises, and why US
government is SHUTDOWN from past month or so.
