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U.S. DEBT

Consequences of U.S. debt crisis could be far-reaching Add to ...

Whatever happens in terms of spending cuts or ceiling levels, the United States’s monstrous $14-trillion debt could have far-reaching, largely negative ramifications for everyone from the decision-makers trying to tame it to homeowners and investors to (gulp) Canadians. As the tortuous toing and froing continues south of the border, Grant Robertson and Tim Kiladze examine the potential effects of America’s epic shortfall and the uncertainty around it on some of the key players.

Barack Obama

In a lose-lose situation, whatever deal is struck

Public opinion of President Obama hinges on which specific deal is, or is not, struck. That’s in part because he has already acquiesced on the tax increases he originally argued so fervently for, and now backs Senator Harry Reid’s plan that does not stipulate higher taxes for the wealthy. He must fight hard to salvage the liberal ideas left in the competing bills to appease his party’s base.

Of the two main options on the table, he will be hurt most by the Republican deal, because it would force the debt ceiling to be reraised right before the 2012 election. The symbolic gesture of tacking on more debt won’t sit well with voters, and it will appear as though Mr. Obama has not stabilized the economy 3.5 years into his tenure.

The main Democratic option isn’t much better, but at least it would push the next debt-ceiling debate out past the 2012 election. Conversely, if Congress itself can’t reach a deal, few people will lay the blame squarely on Mr. Obama. He has made it clear for months that he wanted to get a deal done, and the media has portrayed the partisan bickering as a fight within Congress that is happening away from the White House. Still, as much as President Obama tries to distance himself from the political posturing, not reaching a deal would be disastrous for the country as a whole, if only for optics, and at the end of the day the buck stops with the man in charge.

Republicans

Could suffer a torrent of pre-election blame

The debate over raising the U.S. debt ceiling is as much a political crisis as it is an impasse over fiscal prudence. The Democrats want nothing more than to implement the plan put forward by Democratic Senate Majority leader Harry Reid. Though it would cut $2.7-trillion from the U.S. deficit over the next decade, it would lift the debt ceiling through 2013 and effectively put off the next big flashpoint debate over this issue until after the 2012 election.

The Republicans want that fight in the middle of next year’s presidential campaign to show that they are tough on debt. The two-step plan put forward by Republican House Speaker John Boehner proposes to cut spending by $1-trillion over the next 10 years and raise the debt ceiling. But Mr. Boehner’s plan would require a second vote on the debt limit in 2012, at which time another $2-trillion worth of spending cuts would be placed on the table as the two parties were making a run for the White House.

However, if no deal is reached, the Republicans are at a greater risk of political blowback. Even though the party has used the debt-ceiling fight to undermine Mr. Obama’s fiscal policy, the Republicans could be viewed as obstructionist. That’s residue the Republicans don’t want attached to them as they head into an election determined to cast Mr. Obama as the problem.

U.S. businesses

Staring down ongoing hiring freezes, limited borrowing power

At this point, any deal would bring about a sigh of relief from corporate America. Executives are getting so worried as the deadline grows near that the heads of the country’s biggest banks sent Congress a jointly signed letter on Thursday that stressed the importance of reaching a compromise.

Business leaders have been on edge since the financial crisis first broke because they continue to fear a second recession, and the last thing they need now is more anxiety. Yet reaching a debt deal won’t give them more confidence. Both big and small businesses have been expecting a deal to go through because the debt ceiling has been raised for decades. Having the government agree to it again is simply viewed as the normal course of business. On the other hand, no deal could destroy any lingering morale.

U.S. business owners have already cut back on hiring, which has sent the U.S. unemployment rate ticking higher, and more turmoil will only extend the period during which they refrain from adding new employees. Some of the biggest firms also fear disarray in debt markets. These companies rely on borrowing short-term cash from investors to fund their day-to-day operations. The last time this market froze, the government had to step in and lend to them. Only, this time, that couldn’t happen because the government won’t be able to pay its own bills.

Canadian consumers

Laden with their own debt, facing volatility

The American economy is heavily reliant on consumer spending, and consumers don’t spend when they lack confidence. So while the bond specialists and sovereign-debt analysts worry about Treasury bonds moving half of a per cent higher, what the debt-ceiling crisis boils down to for the average American is passing something that doesn’t rock the boat on household finances.

Should lawmakers succeed in getting a deal in place, consumers are likely to carry on as they were. If the opposite happens, already strained weekly budgets could be tightened even more out of fear that the economy could tank. There are also deeper concerns that consumers may not fully comprehend.

Without a deal, there is a chance borrowing costs will rise, which means mortgage rates could jump higher and lines of credit bear a higher rate of interest. Try convincing an already rattled American to take out a loan that now costs them more money. And those higher costs won’t stop at the border. Canadian banks, too, could be forced to hike rates. Just how much higher is still unknown. But at a time when Canadian household debt has reached record levels in the past year, low consumer confidence and higher interest rates are a volatile mix.

Investors

Susceptible to a ‘reverse stimulus’ effect

Investors are growing more nervous with each passing day, and that has sent American stocks on a five-day slide. This trend is bound to reverse course once news of a deal breaks, but the joy could be temporary. Any bill, regardless of which party puts it forward, will contain spending cuts that function like a reverse stimulus package.

Take Medicare. Forcing seniors to pay more out of their own pockets for health care will hurt their discretionary income, and that is bound to hit corporate bottom lines. As for the macro economy, even if a deal is reached, the U.S.’s massive amounts of debt will still be in the spotlight because Congress must comb through the budget to find what should and shouldn’t be cut. Reminders of that burden will do little to comfort foreign investors.

Should the debt-ceiling deadline come and go with no deal, market volatility will be front and centre. During the worst of the financial crisis, equity and debt markets suffered from wild swings as investors hung on every little piece of news. This time around, fixed-income investors could bear the brunt of the pain because a U.S. debt downgrade will force some money managers to dump their Treasury bonds. (Some of the biggest money management firms and pension funds are mandated to hold only triple-A securities, the safest form of debt.)

Much like an earthquake in the middle of the ocean, anything that happens to Treasury bonds will ripple through the markets.

Mark Carney

Struggling against the dangers of an overheated dollar

The Bank of Canada governor faces a conundrum created by a soaring Canadian dollar. The loonie now sits above $1.05 (U.S.) and keeps getting driven higher by the ever-weakening U.S. dollar. It’s a similar story around the world as investors flock to safe-haven currencies, such as the Swiss franc, which is now at record levels against the greenback. If the U.S. reaches a deal to stave off a default, and the greenback stabilizes, Mr. Carney can go back to managing the Canadian economy as he has been, trying to keep interest rates low enough to ensure economic growth continues heading in the right direction.

If the U.S. talks are derailed, and the greenback plunges further, Mr. Carney will have to take steps to keep the Canadian dollar from overheating. The soaring Canadian dollar, though good for vacationers stepping across the U.S. border this summer, threatens to wreak havoc for Canada’s exporters because American firms will have to cough up more U.S. dollars to buy the same amount of Canadian goods. This has a potential impact on jobs and salaries at home. A hot dollar is one thing for Mr. Carney. An overheated dollar is an entirely different concern.

Follow on Twitter: @timkiladze

 

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