After a long time I am going to write a post on the world economy. Earlier I have written few posts on the topics sovereign debt problem, recession and sub-prime crisis, etc. It received lot of interests from the readers. I felt it is the right time to come up with some global topics which would provide exposure to the current situation of the global economy. There are number of burning issues like US debt ceiling, euro zone crisis, china currency war with dollar,etc.
This article explains the most discussed topic US debt ceiling and how the global economy would be impacted. It is important for every one of us to have the minimum knowledge on the status on global economy which would directly affect the Indian markets. Also, the recent developments shows that countries like USA, UK and Europe are struggling to handle their huge debts which would be result in the defaults.
Let’s jump into the article and will look more detail on US debt ceiling and possible outcome of the issue. You can share your thoughts in the comments section. Please subscribe to our future articles here.
What is US debt ceiling problem?
The current situation of the US government is that it has reached the maximum limit it can borrow from others. The limit is set as $14.3 trillion. According to the reports, the limit has been already reached and they have the time till August 2, 2011 to increase the limit. If the US govt. want to get more loans, first it needs to increase the debt ceiling for $14.3 trillion with approval from the parliament.
The debt ceiling was created after the World War I. This has been increased several times and it is not the first time to increase the limit. But, now the debt which US has is the highest in the history. US govt. never had this much debt in their balance sheet. It creates the problem for them to raise it again to borrow more loans.
If the US govt. failed to complete the deal, there won’t be any money left with the US treasury to spend on the welfare schemes and pay the pension to the govt. employees. It ultimately need to cut all the expenses and stop the projects. It would drastically affect US economy and then spread to the world economy. It is expected that at least some temporary solution to be decided on the coming week. Everyone on the wall street are nervous about the situation and eagerly waiting for the positive outcome.
History of US Debts
The following picture ( source: firstpost )explains the historical data on how the huge debt is accumulated over the years. The existing debt has been increased quickly after the 2008 financial crisis.
The following picture( Source: NyTimes ) explains the creditors who has contributed the debt.
Deadlock with Congress
Since the current debt of the country is very high, it is also a not good idea to increase the debt ceiling without a proper strategy to cut the govt. spending and increase the taxes to reduce the debt burden in the future. Note that, US govt. has to pay the interest for the whole debt on the specified date with bond holders. When the debt amount is getting increased, the interest outgo also will get increased. This would make the things worse if there is no significance increase in the income of the govt.
Keeping the above problems in mind, the current opposition party ( Democrats ) leader John Boehner is not approving the Obama’s plan to pass the debt ceiling bill. It needs to get the approval in the Congress. As of writing this article, till there is deadlock over the issue and no significance progress. If the ruling govt. increases the limit without approval from the opposition party, it would become problem for Obama’s administration. (Read: Fed Readies Guidance for Banks in Case Aug. 2 Debt-Ceiling Deadline Missed)
Gold rush and US debt rating
If you look into the recent rally on the gold prices, it is mounting the all time high of $1,637.50 an ounce. The investors are worried about the future of dollar and want to park their money in the safest place. There are no other best alternative for the dollar (few investors buying into Japan’s Yen) then Gold. The gold rally will continue for the next couple of years till the issue on US debt and Euro zone problems are solved. But, the current level on Gold is at all time high, investors should be careful on investing on the gold.
Every govt. has its rating for their debts. For example, when US govt. needs to borrow money from other countries, they will issue the bonds of short term and long term. This bonds will carry the interest rates associated with it. China has bought more than $750 billion worth of US bonds. It means that China is the largest lender for US govt. as of now. The second largest lender is Japan. US govt. needs to repay the loan on the maturity of the bonds and have to give the interest amount on specified date. If the repay capacity of the loan become difficult for the borrower, in this case its US govt., the rating agencies will cut the rating. Currently countries like USA has the top rating of AAA.
If the rating is downgraded, it would increase the interest rates on the bond prices and getting more money would be costlier for the governments.
Any bad news from the western countries, directly impact all the countries because most of the countries heavily depend on the US for import and export. For instance, China is the largest exporter for US. If any slow down on the economy would directly impact the China’s exports and it would collapse their GDP growth. US consumers has the highest spending habits, there are no other country to replace the USA at any time. So, the impact can not be avoided and every one has to go through the tough times ahead.
The above sections explained the real scenario of the US debt problem and its consequences. If the result is negative, it would shake the global economy and would lead to another recession. This time it will be bigger than the 2008 crisis. We have to wait and watch for the proceedings. I will come up with few more articles on the burning global issues. If you have any ideas, please post it in the comments section.
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