Thursday, May 19, 2011

Will the United States Default?

On Monday the United States hit the debt ceiling which precludes the government from borrowing any more money.  However, Secretary of the Treasury Timothy Geithner apparently has some tricks up his sleeve that will allow the government to keep paying its bills until August at which point it will be forced to start defaulting on its obligations if the debt ceiling is not raised.

All the pundits seems to agree that a U.S. government default would be catastrophic for the economy and that therefore, it will never happen.  The conventional wisdom is that the Republicans and Democrats will reach some last minute deal that saves the day.  I hope this is true and I wish I were as confident.

I cannot help but think about the build up to World War I.   Almost up until the moment that war was declared, financial markets were convinced that Tsar Nicholas and Kaiser Wilhelm would find some way to avoid a war that promised to wreck such devastation.  They were wrong, the two cousins played chicken with each other and drove the world off a cliff.

I also remember September 29, 2008 when the Dow Jones Industrial Average plunged 800 points after Congress failed to pass the financial bailout bill.  Every market pundit was shocked when the House Republicans sent the bill down to defeat.  Although they passed the legislation four days later, many Republicans now insist that it was a mistake.  They may not be so quick to cave in to panic in the financial markets this time around.

The Tea Party Republicans are ideologically committed to spending cuts despite the fragility of the economic recovery.  If the Democrats happen to develop some spine on the issue, I can easily see this ending badly despite the assurance of financial pundits that it will never happen.

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