Saturday, July 23, 2011

A possible U.S. Debt Default and should we be worried?

U.S. Debt Default might cripple the U. S economy and in an interlinked world economy, the ripple effect could be of unimaginable proportion. The impact on other economies, like India, would be grievous. In this post, we are trying to give an overview of the issue and how it might impact the world economy.

What is U.S. Debt Default Crises?
US Govt./Treasury borrows monies by issuing bonds. The govt. will have to pay back the money when the bonds mature. Usually treasury borrows more money to pay back the maturing bonds. By US laws, the treasury has a debt ceiling of $14.26 trillion and cannot issue more bonds once it hits the limit. On August 2nd US treasury debt will hit the $14.26 trillion mark, i.e US govt runs out of money with no option to borrow. What this means is that any US treasury bonds maturing on August 2nd will have to be defaulted. To avoid this, US Congress will have to sanction raising the credit limit, but Congress is yet to do that and the time is running out

The fallout of U.S. Debt Default
For the US economy, it would be catastrophic. A short-term default would be a disaster for the US economy and ruin its legacy as global safe haven. It will result in a downgrade by ratings agencies of America's credit worthiness. This would drive up the borrowing cost US govt and other US institution and business. The US Govt will not have cash to pay for wages of federal employees, military, social security and medicare, etc.

How it would impact the world economy is something nobody really knows. We can speculate that It would devalue the dollar, number one reserve currency of the world. A devalued dollar will hit the export markets across the world and the markets would crash as the profit margins of most of the exporters will get impacted.  The US economy will slow down and will slow the global economy as well. These are some of the obvious worries of the default but we do not what the domino effect will unearth. 

Will default happen?
Majority of analysts consider it unlikely the U.S. government will default on its debt.  And there is little evidence yet of major anxiety among Asia's central bankers, major market players and other key investors from the region.

Obama administration are in contentious negotiations over authorizing additional government borrowing before a $14.3 trillion debt limit is reached on August 2.

Lets keep our fingers crossed and hope better sense prevails among the US congress men.