Pressure builds ahead of US debt crisis deadline

Pressure is on Democrats and Republicans to find an agreement on the debt ceiling before August 2; otherwise, the US will no longer be able to borrow money on the financial markets to pay its bills. FRANCE 24 takes a closer look at the situation.

It’s down to the wire for US President Barack Obama to prod Congressional Democrats and Republicans into raising the debt ceiling. The US has until August 2nd to do so, otherwise they “will no longer be legally able to borrow money to finance government programs”, explained Christine Rifflart, a specialist in the US economy at the French Economic Observatory (OFCE).

On Thursday, the credit ratings agency sparked worldwide concern when it placed Washington's triple-A debt rating on a downgrade watch because of rising prospects that bitterly divided US leaders would fail to strike a deal.

A downgrade could sharply raise US borrowing costs, worsening the already critical fiscal position, and would be hugely psychologically damaging as the US has long been regarded a benchmark among safe-haven investments.

Unlike most countries, US law requires Congress to authorise the government to borrow any money that is needed to pay for its programmes. As the US debt swells, Congress can vote to raise the debt ceiling, or limit, to allow the government to continue borrowing and spending money.

Since the beginning of the economic crisis, US debt has exploded under the combined effect of rising unemployment, reduced tax revenue, and the bank bailouts.

Last May, this debt reached historic heights: 14.4 trillion dollars, surpassing the legal limit of 14.29 trillion for the first time, with the budget deficit expected to hit $1.6 trillion.

“The debt is currently continuing to rise,” Rifflart said. The US debt now represents 95 percent of the country’s GDP – proportionally less than the Greek debt (120 percent of Greece’s GDP), but higher than Portugal’s (90 percent of the Portuguese GDP).

Political bickering

The debate ensuing between Obama and Republicans in Congress has been particularly intense; since taking over the House of Representatives in November 2010, the Republicans have made it their goal to pursue major cuts in government spending, and they have said they will not raise the debt ceiling without a minimum of $2.4 trillion in spending cuts in return.

Obama proposed a series of debt-reduction measures in May that would aim to save 4 trillion dollars by introducing new taxes. Republicans rejected the proposition, calling for cuts in Medicare and Medicaid -- programmes that help the elderly and the poorest Americans -- as the conditions to be fulfilled in order for them to vote to raise the debt ceiling.

A meeting Wednesday night between Obama and Congressional leaders concluded on a tense note, with Republicans later saying that Obama had walked out of the meeting in frustration and Democrats countering that the president had made his case and left what he thought was a closed negotiation session.

“Right now, both sides are upping the stakes with an eye on the 2012 presidential election,” Ethank Ilzetzki, professor and US specialist at the London School of Economics, told FRANCE 24. “But the risk is that they end up sinking the American ship.”

China the arbitrator

China, the U.S.'s biggest foreign creditor, with more than $1 trillion in Treasury debt as of March, called on the U.S. government on Thursday to adopt responsible policies to protect investor interests.

On Thursday, Chinese credit ratings agency Dagong said it had also put US sovereign debt on negative watch for a possible downgrade.

Dagong said the ability of the United States to repay debt was likely to decline given its economic growth was expected to slow and fiscal deficits to remain high in the next couple of years.

In theory, there is no limit to the US debt. “The only limit is China’s good will,” Ian Begg explained to FRANCE24. As long as China continues to buy bonds from the US Treasury -- thereby financing the US deficit – the US economy is kept running. “For the moment, China does not want to stop, because that would lead to a collapse of the dollar, which in turn would lead to a dramatic drop in the value of the enormous quantity of dollars in Chinese coffers,” the British economist added.

But one day, Beijing may want to put a stop to US budget problems. “The best way for the US to show China that it’s capable of honouring its debts is for it to reach an agreement on how to reduce its deficit,” concluded Ethan Ilzetzki.