Monday, October 14, 2013

Monday forum - US default & the implications for 2014

We will see this week whether or not the game of political Russian roulette being played out in the the US will lead to US debt default. It is difficult for someone at a distance to properly understand just what it is happening. If this New York Time story is any guide, it may be equally difficult in Washington. This Economist story on reactions in Peoria is, I suspect, probably not a bad guide to US local reactions outside Washington.

Meantime, major glitches have emerged in the roll-out of the the new insurance exchanges that form a key element of Obamacare. That's not surprising. The technical challenges were obviously considerable. Think NBN for an Australian example.

We now seem to have two choices. Later this week, the US will start defaulting as it seeks to meet daily bills only from the cash collected that day. There has been discussion about the extent to which the US Administration has power to prioritise, to focus on meeting its financial obligations while stopping other Government spend. I imagine that, regardless of the formal position, the US will try to avoid or minimise default on financial obligations.

The second choice is some form of compromise that will at least defer debt default. However, that is unlikely to provide a solution, if indeed a solution is possible.

I am trying to finish a major piece for Australian Business Solutions Magazine on the outlook for 2014. I suspect that you will see my problem. I am reasonably knowledgeable, but I struggle to break free from the shackles set by immediate issues.

I suppose that my immediate personal view is that a short term US default might not be such a bad long term thing, but then the global financial system is now sufficiently vulnerable that no-one can be sure. So to help my thinking, what do you think that the real outlook is for 2014? What would be the implications of a US default? 

Don't feel that you need to limit responses just to these questions. I am looking for inspiration!   


The ripples from a prospective default spread. According to reports in the financial press, a number of the larger US money market funds have sold off their holdings of US Treasuries maturing in late October or early November, boosting their cash holdings and pushing short term interest rates higher. Short term funding issues are starting to emerge for US banks as well.

Writing in the Australian Financial Review, Karen Maley says that the impasse is now placing pressure on the $US5 trillion per day repurchase or repo market. In this market, banks or other borrowers use Treasury Bills as security for short term borrowing purposes. Say you need overnight cash, rather than trying to sell securities, you pledge them for cash from the money market funds. If you cannot pledge those Bills, you have a problem.

I imagine the the Federal Reserve could actually do something about that by pledging to buy Bills at face value or even at a premium to cover any missed interest payments. That would also provide protection for non-US holders.

Still, it is uncharted waters. 


Anonymous said...

I heard on the news the other night that the US debt was somewhere north of $16Tn, of which some $4Tn was "owed to itself" - a thing I don't understand: who knew the government had two pockets, as well as a hand in our own?

Anyway, of the remaining approx $11Tn China was in the game for a bit under $2Tn, which is another thing I don't understand: why would a creditor talk down a debtor?

It's all very confusing; I think I'll check that my pockets are securely sewn closed, and hope the Chinese see some sense.


Jim Belshaw said...

I suspect that the $4T owed to itself is via the Federal Reserve.

I hope that you do keep your pockets sown securely shut! Can't blame the Chinese when as creditor they see such strange behaviour!

Anonymous said...

I remember where I saw that now. It was a rare Alan K pie chart on ABC News. Typical for the simplistic yet colourful portrayal of a weighty subject - and also misleading as usual.

So anyway, explain to me why (now that a 'deal' appears likely) the US govt couldn't simply print some more money and at least pay off the $4T it "owes itself"?

What I mean is, what is itself then going to do with that $4T once it has moved it from right pocket to left? The most expected thing would be to immediately reinvest it in US bonds - i.e. move it back from left pocket to right, but with an extended repayment date. No?


Jim Belshaw said...

Good morning kvd. If the US gov borrows from the Fed, it is still caught up the debt ceiling.

Anonymous said...

So you think the mere act of printing more money creates "debt"? At best, I think it may create a heavily discounted long term 'obligation to honour' - but not one-for-one debt as such, except for the cost of printing.

Isn't this just what our federal government is doing in considering the 'securitisation' of our $26Bn of student loans, of which it is suggested $6Bn will never be recovered?


Jim Belshaw said...

Mmmm, kvd. Part of this is an accounting issue, but not unimportant. The Federal Reserve creates money that it lends to the Government. Treating this as a debt provides discipline.

Securitisation of student loans is a different matter. Here our Feds have treated student support as a loan. If they can sell that loan, they have more cash to spend.

Anonymous said...

I see no difference in base accounting.

The Federal Reserve prints money - which I called creating an 'obligation to honour' - and it's interesting that this is acknowledged by the pledge "In God We Trust". Good old double entry bookkeeping only starts with Treasury which acknowledges the 'debt' to Fed, and thereby has an asset it can then on-lend.

In the case of student loans, our government may find attractive the orderly 'sale' of (heavily discounted) student loans. They will move a nominal $26Bn off their books for probably $10-12Bn. They are creating a saleable asset out of unrealisable third party obligations (the repayment of which they do not, and cannot, control - i.e. "in God we trust"), priced so as to attract a conservative buyer.

I can't see much difference.


Jim Belshaw said...

It's all definitions, kvd. That's what the world runs on!