Unless you have been under a rock for the last month or so, you have likely at least heard mention of something called the debt ceiling in the paper or on the news.
Essentially the issue on the table is that the American Federal Government, on or around August 2nd, 2011 will officially be out of money. Technically speaking, this means that any expense typically paid out via the Federal Government will not be paid. The most talked about reprecussion would be a default on American debt, and in particular treasury bills which have long been considered risk-free. However, on a practical level, a number of other expenses would also cease to be paid including welfare cheques, government worker salaries, and the operating expenses for libraries, museums, courts, etc.
For a number of years the US Government has been running a deficit, most recently exascerbated by the financial crisis, but present for many years before as well, meaning that year after year it is borrowing more money to finance its expenses. The legislative solution to the immediate problem of getting money is to raise something called the debt ceiling, essentially a federal debt limit imposed by Congress and raised occasionally on an as needed basis. Raising the debt ceiling is not an unusual thing
(See this graph http://http//www.washingtonpost.com/blogs/ezra-klein/post/thirty-years-of-the-debt-ceiling-in-one-graph/2011/07/11/gIQAEJdEGI_blog.html) however what is out of the ordinary is the brinkmanship that seems to be taking place in both parties as they get closer and closer to the end.
A number of misunderstandings have surfaced in discussion of this issue and while I have neither the time nor the energy to address them all, I will try to tackle the most glaringly inacurate. The first, and perhaps most fundemental misunderstanding is that raising the debt ceiling is an indication of new spending. It is not. As it happens, the debt ceiling must be raised simply in order to pay the bills on spending that has already been legislated, much of it under previous governments.
The second misunderstanding is that the debt ceiling drop dead date (August 2) is some kind of scare tactic by the US Treasury and that the government could really continue paying its debts long after this. This belief requires either a misunderstanding of the financial responsibilities of the American Government or else a belief that Obama and/or the rest of the government is actively lying and intentionally deceiving the global public. As for myself, I am not much of a conspiracy theorist and given the large degree of independent verification from non-partisan institutions, I find the August 2 date to be credible.
The third and final falacy I will try to address is the notion that even if the debt ceiling is not raised and the US Government does default, this would be just the kick in the backside the government needs to motivate it to finally get spending under control and the short term cost now would pale in comparison with the benefits of cost cutting that would follow. This point is one degree more difficult to address as it is essentially speculation and cannot be proven one way or the other until it happens. However, given the historic nature of a US Government default coupled with the global tendency to see said debt as risk-free, I think it is more likely than not that interest rates would rise substantially causing further burden on an already struggling economy. I know if I had $14 Trillion in debt, I would do everything in my power to avoid an interest rate increase.
So what does all this mean for Canada? I think it is important to note that the Bank of Canada, the Canadian Government and most international institutions still believe that the likelyhood of a default is low. That said, were it to happen, a number of consequences would likely impact Canada. Initially the Canadian Dollar along with a basket of international currencies seen to be stable would rise verus the US Dollar as investors sell it in favor of more solvent countries. Soon after, there would be a noticable drop in cross-border trade with the US (assuming an extended default) as those goods and services usually purchased by the Government would no longer be purchased. Eventually, likely sooner than later, an agreement would be made to increase the debt ceiling and pay overdue debts at which point things would gradually move back towards something approaching normality though the repercussions would be felt for a long time.
You have likely noticed that I have not addressed the political issues of Democratic versus Republican bills, philosophies, and posturing. That is because, not only would that require an entirely seperate blog post, but it also detracts from an apolitical understanding of the underlying issues. If you would like to explore those issues, I would recommend the following sites:
http://www.economist.com/blogs/democracyinamerica
http://www.nytimes.com/pages/business/index.html
http://www.forbes.com/
As always, if you have any other questions, comments, or anything else please let me know.
