Debt Crisis Prompts Global Angst

Analysis Brief

Debt Crisis Prompts Global Angst

August 2, 2011
Author:
Jonathan Masters, Associate Staff Writer

After months of impasse, an agreement that raises the U.S. debt limit (BBC) ahead of default was signed into law on Tuesday afternoon. But critics at home and abroad are expressing annoyance at what they see as a U.S. political system incapable of overcoming partisan rancor in conducting essential national business. The Budget Control Act of 2011 (WSJ) allows up to a $2.4 trillion rise in the debt ceiling (in three tranches), immediately institutes ten-year discretionary spending caps totaling nearly $1 trillion, and creates a bipartisan committee charged with identifying mandatory deficit reductions of at least an additional $1.5 trillion by Thanksgiving.

Expectations of a long-awaited U.S. debt deal drove "relief rallies" in foreign markets, including gains in the major European and Asian indices, but economists suggest the increases may only be temporary given that the expected agreement does not dispel fundamental investor concerns over a weak U.S. economy (FT). While U.S. markets initially surged on the news from Washington, reports of dismal growth in domestic manufacturing helped precipitate a commensurate sell-off and fed fears of a wider economic slowdown. Questions also remain as to a whether the country will receive a downgrade in its top credit rating (NPR).

Some major U.S. debtholders in the international community expressed displeasure about how the United States has managed the debt-ceiling crisis. Speaking at a political rally, Russian Prime Minister Vladimir Putin (WSJ) maligned the United States as "a parasite" due to its mammoth debt obligations, and encouraged Russia and other nations to seek a new reserve currency. A recent editorial in Xinhua, a state-run Chinese media outlet, called the debt-ceiling showdown "dangerously irresponsible" and urged the United States to "to conduct an in-depth self-examination."

Morgan Stanley's Stephen Roach, writing on the reaction in Asia (ProjectSyndicate), says the recent fiscal brinkmanship has driven a loss of confidence in the U.S. government and its global economic leadership. In the wake of the U.S. subprime crisis, which sparked a global financial meltdown, Roach says the debt-ceiling debacle "is the last straw" for Chinese officials, who are "appalled at how the United States allows politics to trump financial stability." Beijing is particularly vulnerable to any uncertainty in the U.S. debt market, with some 60 percent of its $3.2 trillion in forex reserves parked in dollar-denominated assets. Writing for the Diplomat, Minxin Pei says this "$2 trillion hole" may force "a more rapid pace of revaluation of the renminbi," as China seeks to reduce its vast current account surplus.

International investors have yet to jump ship from the U.S. Treasury market, despite their obvious qualms. In fact, bond prices (CNN) increased throughout the debt crisis, including last Friday, though after Congress reached a deal on Monday, prices actually fell. Analysts claim this seeming paradox indicates that investors are less worried about excessive U.S. debt than fundamental economic conditions (U.S. manufacturing) and a steady supply of treasuries.

The budget compromise assures that fiscal policy, at least in the short term, will not be used to stimulate a sputtering U.S. economy, even though many economists have called for greater federal spending to sustain a recovery. The deal also ensures that much political theater lies ahead, as policymakers try to flesh out the details of proposed cuts. Writing for TIME, Michael Schuman suggests this translates into prolonged uncertainty in global financial markets. "If I were a policymaker in Tokyo or Beijing or New Delhi, I'd want to make myself less dependent on a country where the political process appears unreliable and heightens the risk to the global economy."

Selected Analysis:

While the United States may avoid a crippling default, the country still faces a "democracy crisis," and needs reforms to allow Congress to act effectively, write Jacob S. Hacker and Oona A. Hathaway in the New York Times. Reforms are needed that allow Congress to act effectively.

The best way to bring the U.S. debt-to-GDP ratio under control is to limit future spending increases, particularly in healthcare, and boost revenue while the economy continues to recover, testifies the Peterson Institute's Simon Johnson before the House Ways and Means Committee.

The United States can solve its debt crisis, but sustainable prosperity lies in improved productivity and real wage growth, not asset bubbles, writes Larry Elliott for the Guardian.

The brush with a U.S. default and lingering fiscal woes increase the appeal of a balanced budget amendment, writes Edward Glaeser for Bloomberg.


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Tel Aviv Stock Market Crashes as Panic Grips

Sunday, 07 Aug 2011 01:11 PM

Hysteria swamped the Tel Aviv Stock Exchange (TASE) today when the Tel Aviv 25 Index plunged 7 percent to 1,074.27 points, according to Globes.

The opening of trading was delayed nearly two hours, from the usual 9 a.m. to 10:44 a.m. when the automatic shut-off kicked in, Globes reported.

The panic came on the heels of the TASE's worst week since 2008, exacerbated by Standard $ Poor’s downgrade of U.S. credit Friday night and Friday's steep drops in international stock markets. Also contributing were fears that Europe’s debt crisis will spread.

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Asian Markets Open Down After Downgrading of U.S. Credit Rating

By DAVID KERLEY (@David_Kerley) and JORDYN PHELPS
Aug. 7, 2011

Tokyo's Nikkei stock market opened down 1.4 percent and then made slight gains, but Japan's finance minister reportedly said the country has not lost faith in the dollar or U.S. Treasury bonds even after the U.S. credit rating was downgraded for the first time in history.

The news in other Asian markets was not so promising. Australia's S&P/ASX-200 index lost almost 2 percent in early trading and indexes in New Zealand fell more than 3 percent.

The mixed reports likely won't do much to quell growing concerns that Standard & Poor's downgrade of the U.S. credit rating from AAA to AA+ could rock global financial markets.

There are efforts across the world to calm markets in light of the downgrading, which all weekend the White House has been fighting in some very strong language, calling it "amateurish" and "breathtaking."

President Obama himself, however, has not spoken. Returning from Camp David today the president waved off reporters asking questions about the first downgrading ever of U.S. credit.

The president and his economic team will be talking with leaders from around the world tonight, bracing for the impact from the move by S&P.

Even with the administration's heated criticism of S&P over the downgrading, the rating agency is not only standing by the decision, it is saying a further downgrade is possible if the United States doesn't solve its debt problem in two years.

The rating agency's managing director John Chambers said today on ABC News' "This Week with Christiane Amanpour" that there's "at least a one in three chance of a downgrade over that period."

He has blamed the downgrade squarely on Washington politics, saying "this is not a serious way to run a country."

"Our job is to hold the mirror up to nature, and what we are telling investors is that we have a spectrum that runs from AAA to D," Chambers told ABC News. "And what we're seeing is threat the United States government is slightly less credit worthy."

The rating agency says that Washington has shown an inability to reach political consensus, which was highlighted by the debate on the debt ceiling, and this leaves the U.S. "less stable, less effective."

S&P is one of the three major rating agencies that highlight investment risk, and is considered a golden standard among rating agencies.

However, all three agency's reputations were tarnished after mortgage-backed securities that they gave a AAA rating contributed to the economic collapse of 2007 and 2008.

After S&P was pulled before Congress to testify about the faulty ratings, some now question the organization's reliability.

"Now they come in and they flex as if they've been this bastion of correctness when they've completely been wrong and so now everything they do is suspect in my view," said president of Ariel Investments Melody Hobson.

Some wonder if S&P is rating the political system instead of the financial system.

While the White House pushed back against the downgrade, pointing out that the rating agency made a $2 trillion math mistake, White House spokesman Jay Carney conceded that reaching compromise on the debt ceiling debate took "too long and was at times too divisive."

"We must do better to make clear our nation's will, capacity and commitment to work together to tackle our major fiscal and economic challenges," Carney said in a statement.

Many experts are saying not to read into the ratings downgrade too much, pointing out that the other two major rating agencies still have the U.S. ranking at AAA and saying that the United States is still in a strong position.
PHOTO: A money trader reacts in front of a monitor for the yen-dollar exchange rate at a money market brokerage firm in Tokyo.
Shizuo Kambayash/AP Photo
A money trader reacts in front of a monitor... View Full Size
PHOTO: A money trader reacts in front of a monitor for the yen-dollar exchange rate at a money market brokerage firm in Tokyo.
Shizuo Kambayash/AP Photo
A money trader reacts in front of a monitor for the yen-dollar exchange rate at a money market brokerage firm in Tokyo.
Foreshadowing What's to Come on Wall Street Watch Video
America's Credit Crisis Watch Video
U.S. Credit Downgrade: How It Effects You Watch Video

"We've only gone down one step," said Donald Marron, former acting CBO director. "The ratings have you know 20 different levels to them. We're down at the second level, so this is not saying we are doomed by any stretch but it's saying that they do have some concerns about us."

Still, the downgrade has left many Americans concerned that the country is losing its footing as the global leader.

"We have to figure out though how we're going to play going forward and I think if don't get our house in order we're in danger of slipping in our ability to interact as a global player," said Gary Knell, a resident of New York.

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