Failure to reach a compromise on a U.S. debt ceiling increase could result in an unmitigated economic disaster - one so unprecedented government and private analysts can't even accurately pinpoint all the potential consequences.
To avert this crisis, U.S. President Barack Obama wants a debt ceiling increase of $2 trillion, which analysts say would carry the country through the end of 2012. The president has moved the deadline for reaching an agreement up to July 22.
President Obama said the time cushion was needed to prevent a last-minute panic by the financial and debt markets that could "potentially create another recession" - panicking investors and possibly causing an economic meltdown even worse than the one in 2008.
But even after a debt ceiling increase is approved - though it would obviously produce a brief sigh of collective fiscal relief - the U.S. economy and markets will suffer painful effects, and almost no longer-term positive impact.
So what can investors expect once the U.S. debt limit is, in fact, raised?
Higher Rates and Inflation
The prospect that the country will be able to add $2 trillion to its tab over the next 18 months is unlikely to make potential lenders (i.e., buyers of Treasury securities) jump with joy.
Just ask your credit card companies for a 13.98% increase in your borrowing limits - assuring them you'll use every bit of it - and see what it does to your credit score.
This means a debt ceiling increase is likely to lead to a downgrade of the U.S. credit rating, which will cause investors to demand higher rates to compensate for the increased risk.
To gauge just how much higher, JPMorgan Chase & Co. (NYSE: JPM) recently surveyed its clients to see what they thought. According to The Washington Post, respondents from within the United States told the bank they expected rates to rise by 0.37%, but foreign investors - who hold about half of outstanding U.S. debt - predicted a rise of half a percent or more.
A rate increase of that size would boost U.S. interest payments on new debt by more than $7.5 billion a year. The cost of rolling over existing debt at those rates could rise by as much as $71 billion a year.
And there's no guarantee the increase would be short-lived. When a combination of similar events forced a two-week delay in U.S. debt payments in 1979, a study conducted 10 years later found it had caused interest rates to rise by an average of six-tenths of a percent for more than five years.
More borrowing and higher interest rates also will mean more inflation.
After all, even if the Republicans in Congress back down and allow some federal tax increases, there's no way those being discussed will be enough to cover the increased debt burden - or even the increased interest payments, for that matter.
The only way the U.S. can pay the increased interest - forget about principal - is to print more money. That means a weaker, devalued dollar, and higher prices for everything priced in dollars.
Beware the Market's Reaction
If (or when) the debt ceiling is increased, both stock and bond markets are likely to celebrate for a minute. Then they'll re-examine the longer-term effects and turn sharply lower, perhaps extending the slide for quite a while.
That possibility was demonstrated quite clearly back in the spring when, following S&P's April 18 decision to downgrade the outlook for U.S. debt to "negative" from "stable," the stock market's extended rally quickly stalled out and the major averages began a six-week slide. That drop carried the Dow Jones Industrial Average from 12,807 on May 2 to 11,897 on June 15.
Now the stock market is notoriously fickle, which it proved when the Dow then rallied back to 12,719 on July 7 -- in spite of the looming debt deadline.
But then it dropped 202 points last Monday and Tuesday, choosing to ignore President Obama's debt assurances and instead focusing on the growing European sovereign-debt crisis and S&P's threat to lower its ratings on U.S. Treasury securities.
If you have large stock positions that could be at risk in the event of a market collapse, you might protect yourself by purchasing put options on either your individual companies or on stock index exchange-traded funds (ETFs).
Starting a Never-Ending Cycle
The acrimonious debate we're seeing over a debt ceiling increase likely will exacerbate the political divide in Washington, making the federal government gridlock even worse than it has been. In fact, it's almost reached the point where the fight is more important than the issue itself.
Such a series of political standoffs, legislative logjams and other major inactions brings the final major consequence arising from this conflict: the prospect that we'll see a debt ceiling increase again ... and again ... and again.
The current request is for a $2 trillion increase - only enough to allow the government to keep borrowing until the end of 2012. Under the president's proposed budget for fiscal 2012, the level of publicly held debt will rise from $10.4 trillion at the end of 2011 to $13.2 trillion at the end of 2012 - and borrowing for 2013 would require lifting the ceiling yet again.
What's more, the upward debt spiral will increase - no matter what we do. With spending at current levels, the public debt will grow from today's $10.4 trillion - roughly 69% of gross domestic product (GDP) - to $20.8 trillion, or 87% of GDP, by 2021. The interest payments alone will grow fourfold to $800 billion a year, or 3.9% of GDP.
The impact of the debt service on the economy also will inflict damage, reducing the amount of money available for new investment and growth, and resulting in an annual drop in GDP of 0.7%, or 3.8% of the total, by 2021.
Of course, all these possibilities pale beside the outlook should Congress and President Obama fail to reach an agreement to increase the debt ceiling. The impact of even a one-month suspension of Social Security and Medicare payments - one proposed "temporary fix" - would surely cripple the economy and collapse the markets. And anything worse could be the gateway to a new recession - or even depression.
Be prepared for the debt ceiling increase by examining your areas of highest financial vulnerability and engaging in defensive investing: Take some steps to hedge your risks using such investment tools as options, inverse ETFs or precious metals.
News and Related Story Links:
- Money Morning:
America for Sale: Liquidate Assets to Avert Debt-Ceiling Crisis, Republicans Say - Money Morning:
S&P Downgrade Shows U.S. Debt Crisis Could Have Dire Consequences - Money Morning:
Profit From Inflation: These Six Stocks That Will Add Punch to Your Portfolio - MSNBC:
Debt ceiling talks entering uncharted waters - CBS MoneyWatch:
Raising the U.S. Debt Ceiling: Much More Than a Slogan - The Washington Post:
Five myths about the debt ceiling - Reuters:
Analysis: Regulators weigh Greek risk to money funds - Reuters:
Treasury secretly weighs options to avert default - ExecutiveGov.com:
5 Things You Should Know About the Debt Ceiling
Here Are 10 “One-Click” Ways to Earn 10% or Better on Your Money Every Quarter
Appreciation is great, but it’s possible to get even more out of the shares you own. A lot more: you can easily beat inflation and collect regular income to spare. There are no complicated trades to put on, no high-level options clearances necessary. In fact, you can do this with a couple of mouse clicks – passive income redefined. Click here for the report…
The national debt is 14.? trillion. The GDP is 14 trillion. By my calculations we are already at 100% debt to GDP. That is assuming we can call positive GDP the last 3 years due to gov't spending providing at least 10% of the economic growth through borrowing and spending. In my book that is fraudulant GDP.
My next problem is we have never gotten out of the recession of 2008. In fact we ARE in a depression but we haven't felt the full effect due to massive gov't borrowing and spending. This is like saying your lifestyle hasn't changed since you lost your job because you still have credit cards.
I know federal spending is part of GDP but subtracted from that number should be the amount of the deficit. After all we are interested in how the pricate econmy is doing not how the Federal gov't is manipulating the numbers.
This country has fixed none of the problems that caused the panic of 2008, we have only papered over them with massive borrowing. If not now, when do we get our fiscal house in order?
I'm under the impression that Social Security checks are paid out by a separate account – one that is NOT impacted by the elevation of the debt ceiling.
On the off chance that the debt ceiling is not increased, will the Stock Market crash? Should I sell my stock today and simply buy it back when things get better. I understand that the market is in a volatile mess, but I have great faith in the USA. What are your feelings on this
Edward Osler
It's time to close the valve on the RED INK flow from the Government, at all levels. Follow the money, who is lending the money, and what gives the money we borrow any value. If the money comes from the Federal Reserve, isn't it just paper money. Certainly, Bernanke doesn't"t really have any assets (gold reserves) that give the money they lend any value… If the money comes from China, they only have their threat of force to back up their money, i.e. mafia tactics to make us pay. The words, Full Faith of the U.S. Government, will mean little and eventually it will have to use mafia tactics (Hitler style) to extract any wealth (at depreciated values) the citizens may have to pay off those from which we, the people, have borrowed money. Isn't that essentially what Obama wants to do now. Use the full force of government to extract even more money from citizens to pay for ineffective economic policies, all to buy votes from desperate citizens, that truly believe that using government to take money from others for the very own benefits is morally okay! Robin Hood style government?
Obama and his clique have no concern for the American economy nor the Americans that live in it. He wants to see the US go down in flames. He and his minions already have their overseas accounts in order and a place to hide. The 51% of Americans(?) voting in the us and paying no taxes have nothing to lose, thus indicate more tax is good. Obama's administration will end with nothing but terrible bad results and the idiots that voted him in will still be trying to blame Bush for the Obama fiasco.
Govt is way to powerful and too large to be run by American voters,who are short term greedy and long term stupid.This country has been in decline since at least the late 1960's.The decline is accelerating as we become more bankrupt.I don't know if there is much we can do about it.Every leading country,throughout history,eventually went into decline.During the last few centuries the leading countries were in Europe,then U.S. and now it's Asia's turn.Eventually the Asian countries,if they continue to get wealthier, will become fat,lazy and then go into decline.
Good recipes are proven by the old saying, "the proof of the pudding is in the eating."
When Clinton became President following twelve years of massive Republican debt spending, he proposed a budget that was bitterly opposed by the G.O.P.. Eight years later, the Nation was doing exceedingly well, the debt was being paid down, and there was a surplus of hundreds of billions. There were even some economists that worried about the Nation having no debt. Obviously, Clinton's budget worked.
All that ended when Bush tossed out the Clinton "budget recipe"; launched a couple of off-budget wars; created TSA, a huge federal bureaucracy; added Part D, to medicare (a windfall to the drug companies); and then decided on a massive tax reduction policy. A financial plan akin to someone going on a spending spree, then quitting their job.
What is now incredulous, is that the Republican Party refuses all efforts to restore the tax income that largely created the financial nightmare. Clearly, their budget recipe has failed the taste test. It is also clear that throwing trillions of dollars at Wall Street will never solve the problem.
Cutting spending without raising income is a zero sum game. Until the federal government returns to tax rates that have proven themselves over the years, the crisis will continue to worsen and the World may very well be plunged into a terrifying depression.
We are watching children playing with matches in a room filled with gun powder.
Everything that we read in the papers and on the news, indicates that Mr Obama is not for the American people. If they would first put all of our Whitehouse politicians on a salery like the common man, you could go along way to pay off the debt our country has. In addition to that, all the unnessary trips that are taken by Obama(per the military comments on flight cost) and the exaggerate vacations,etc that Mrs Obama partakes in,the debt could then again be lowered.
As an employee in the State system or the Goverment we do not get our salery for the rest of our lives, nor should thoses in political positions.
Many Americans live and raise families on meager incomes. We look forward to the little return of Social Security that we have contributed to over our working years. We have allowed many that have not worked in the United States of America, are not citizens of America and openly hate us but want to live in the land of freedom to accept monies from our tax dollars. Not right.
Mr. Obama needs to go back to where he came from and corrupt their beliefs in their God and Country and leave ours to some one who cares about the American People.
The writer has not dug deep enough to find the fundamental cause of our predicament.
At the foundation one finds not an abstraction or representation of reality such as money and its miriad manfestations, which is the domain of the left brain, but reality itself. The reality that our energy bonanza has peaked and is going away forever. Global peak oil happened in 2005. All our rationalisations will not save us. To restart the party we need a new source of energy such as Rossi's recent demonstration.
http://en.wikipedia.org/wiki/Rossi_Reactor
Loyst Streeter hit ythe nail squarly on the head. To reduce the US debt, tax increases and changes are a MUST. There are billionaires in your country that are enjoying tax loopholes like no where else in the world, which if they were taxed fairly could reduce the deficit quite substansially. When you look at companies like GE paying NO tax last year to the US government, ther has to be something wrong with this picture. From a Canadian's rospective, too many big businesses have the congress in their pokets.
From MOncton, New Brunswick, Cananda
I think the best option that could be utilized here is the Federal Reserve Put: Repudiate any and all debt "owed" to the Federal Reserve Bank. This will force the Federal Reserve into insolvency. Then we could create a new and sound financial system similar to what we had before 1913. After all, we did not have devaluations anywhere near as bad as we've had across the last century.
The national scale in economics is in the end the same as the business scale. When bankrupt it is best to own up to the bankruptcy: these discussions should refer to the Chinese credit rating assignments for Soverign states, not the falsified US based rating agencies.
– declare bankruptcy
– implement gold as the new currency, removing from politicians power the ability to manipulate the money supply or the interest rate
– by constitutional amendment take away from politicians the right to borrow money and assign it to payback periods beyond their term in office.
We raised the debt ceiling what, about 10 times or more over the last 10 years under Bush? The doom and gloom you predict seems to be a scare tactic. Debt by itself is not bad. You have to look at the income coming in. A guy paying $10,000 a month for a mortgage seems high, until you realize he makes $1M a year. We need to increase the income for the government and the debt problem will resolve itself. The market has done great with high government debt in the past. Again, the republicans play the supply side economics game, saying that we cannot raise taxes on the high earners because we need them to create jobs. Well, taxes were not raised the last 2 years, so they still have Bush's tax breaks. Where are the jobs? You do not blame presidents for jobs. They do not create them. The businesses are hoarding cash and the fat cats are banking their huge profits. It is all politics, pure and simple. Republicans say do not take money from the high earners. take it from retirees on social security or from other programs that impact the less affluent. They want to take care of their constituents, who are not the middle class. The republicans want to get back into the White House, so they are doing everything in their power to make the country fail. This will backfire on them, again.
Thanks, some of these comments are priceless. They help explain how we get clueless politicians. We already have a solution for out of control government. See the Constitution, 10th Amendment. These limitations were there for good reason: power corrupts. Limiting central power limits corruption to a manageable level. We have allowed the political class (now our nobility) to gain tyrannical power illegally thru misconstruing interstate commerce and general welfare provisions. This will end very badly, unless we rise up and demand that the federal government return to its legally authorized duties, primarily national defense and international relations. Then the other 75% can be shifted to the states if they want it (unlikely), privatized (the free market most efficiently determines value), or phased out. Between the direct savings and the tremendous resulting boost to the economy, the debt crisis would be manageable. Allowing political insiders to run things (socialism) has once again proven disastrous.
Guess Ben Ladin was correct in saying that the U.S. would be torn down from within, so far his prediction seems to be correct, might even be one of those in the White House right now…Could be. The republicans say they will not go along with any type of tax increase, what do they think reductions in benefits to Medicare-Medicade and other programs amount to…a tax increase on the poor not the wealthly, makes more sense to tax those of us who can afford the tax versus those who are just barely getting by now..Increase tax on those who can really afford them,leave the Corporations and small business alone providing that they provide more jobs here in the U.S. and stop shipping our technology and jobs overseas due to greed for stockholders. Never should have woke China up, we will pay greatly for it over the next 20 years and also should have left India alone as well, they will eventually take control of the world,wait & see.
One other point, Doctors are not the culprits near as bad as the Hospitals, they have increased cost thousands of percent over the last few years, thibnk not, why have room rates of which many rooms were donated by the communities ahve risen from $80.00 a day to over $1,000.00 in small communities and x-rays have gone from $50.00 to over $500.00 not counting out patient visits to the hospital, try this part and see the outragis costs involved. The hospitals are the ones that shopuld be under the gun, not the doctors.
The U.S. Dollar is a serious devalued problem, guess we are now feeling how Canada and Mexico felt a few years back. The devalued dollar may be good for exports but it is sure costing all of us on inflated prices which has only just started. I am not radical, just calling the shots as I know them to be from being involved in all the above.
Bitch & Compalin to no avail, but never solving the problem via politicians, need those with lots of ten year and power out of government and shorter set term limits of four years max during lifetime.
why the worry about debt when 90 % of the world are in debt. It is all a relative game and the whole world is so related with one tsunami and every country trying to push the epic center to some other position.The mere result is how powerful each country to suppress the influence of the tsunami turbulence.The USA got the space by virtue of its power to dissipate that influence all over the world which has no choice but to follow and absorb.If Europe supporting Greece against default, the whole world, indirectly and with no other choice, has to support USA .One could argue that China is in surplus,but measuring against its whole population ,if raised to same networth of average American citizen household,China would be at much higher debt level.