US edges closer to debt default

2011-07-25 11:00

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Washington - A sharply divided Congress pursued rival budget plans on Sunday that appeared unlikely to win broad support, pushing the United States closer to a debt default that would reverberate around the world.

With time running out, Democrats and Republicans split into two camps and held talks among themselves. Both sides appeared unwilling to compromise to head off a default that could trigger global economic calamity and strip America of its coveted Triple-A credit rating.

Lawmakers missed a self-imposed deadline to produce a deficit-reduction deal by the time Asian markets opened on Monday, despite fears investors would finally lose patience and punish Washington for its gridlocked political system.

But the markets surprised with only a mild rebuke, even though the August 2 deadline for action was only nine days away.

After weeks of rancorous talks, finger-pointing and political point-scoring, both sides appeared still far apart on a broad deficit reduction deal that would clear the way for Congress to raise the $14.3 trillion debt ceiling.

The congressionally set debt ceiling caps how much the United States can borrow. The US Treasury says it will run out of money to pay the country's bills by August 2.

Boehner plan a "non-starter"

President Barack Obama on Sunday heard details of a Senate Democratic plan that would rely on spending cuts, not new tax revenue, which would violate one of his key demands.

House of Representatives Speaker John Boehner, the top Republican in Congress, meanwhile advocated a two-stage strategy that would require lawmakers to raise the debt limit again early next year - as Obama, a Democrat, runs for re-election.

Ratings agencies have already made clear they would oppose a short-term debt ceiling increase and Senate Democratic leader Harry Reid called Boehner's plan a "non-starter".

Plans to cut hundreds of billions of dollars from the national debt have been proposed and then quickly discarded as the debate has degenerated into an ideological battle with both sides increasingly dug into entrenched positions.

Republicans, driven by the fiscally conservative Tea Party movement that helped them win the House last November, strongly oppose tax increases, while Democrats who lead the Senate dislike proposed cuts to popular social programmes.

Obama, struggling to bring down the 9.2% US jobless rate, and Republicans will face voter outrage if a compromise cannot be found in the high-stakes drama.

Markets wary

Asian market reaction to the continued stalemate in Washington was relatively modest as investors pulled out of riskier investments like stocks and headed for safe haven assets like gold, pushing the metal to a new record.

US stock futures fell, signalling a poor open for US markets and showing that investors were increasingly worried about the failure of lawmakers to coalesce around one approach. Early currency trading suggested a move away from the US dollar, with the biggest drop in the greenback coming against the Swiss franc.

"The fact that they seem to be jumping from one type of proposal to another and not converging on anything is beginning to worry markets," said Steven Englander, head of G10 FX strategy at Citigroup.

Republican Representative Jack Kingston summed up the mood: "This is a like a long labour, with the dad in the waiting room, waiting to see if it's a boy or a girl and the doctor's coming out and saying 'I can't tell you yet'."

Financial markets have been betting the United States will not default, but investors are deeply worried that the US's credit rating will be cut if Congress and the White House fail to craft a long-term deficit reduction plan that satisfies the ratings agencies.

So while markets are keeping their cool now, as days tick by with no deal in sight, the United States could begin to pay the price for inaction with investors moving out of the dollar and Treasuries.

Two-stage strategy

A downgrade would force up the cost of US borrowing, hurting an already weak economic recovery and possibly pushing the country back into recession. With the United States one of the main engines of the global economy, the fallout would be felt worldwide.

Reid's Senate plan envisions a cut of $2.7 trillion in government spending over a decade to allow for a vote to raise the $14.3 trillion US debt ceiling by August 2 and extend the government's borrowing authority through 2012.

Significantly, his plan does not raise tax revenues, which is in line with Republican demands. Without including tax revenues, however, it would violate Obama's principle that any deal be balanced between cuts and more taxes on the wealthy.

Boehner's two-stage strategy would see Congress raise the debt limit by about $1 trillion, with a similar amount of cuts to annual discretionary spending. That would give lawmakers roughly seven months to overhaul the tax code and wring further spending cuts from social benefit programmes like Medicare.

Boehner is due to outline his plan on Monday afternoon.

With the clock ticking, it was unclear how the two bills, if they pass their respective chambers, would be merged into one measure that Obama could then sign into law.

Read more on:    barack obama  |  us  |  economy

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