The cloud of debt that is hanging over the US

WHILE the European debt crisis rumbles on, there is also a storm brewing across the Atlantic. As European finance ministers squabble, the GOP and Democrats are locked in a battle of their own. This row has fuelled uncertainty from investors as to America’s ability to address its enormous debt burden. But if they are to avoid missing a coupon payment on their debt, the two parties are going to have to put partisanship to one side and set out a credible plan.

Trevor Greetham, director of asset allocation at Fidelity International, foresees an interim peace treaty that will be more style than substance: “We expect the political parties in the US to reach a deal that will allow the federal debt ceiling to increase and will allow enough by way of token spending cuts to allow both parties to save some face.” Greetham adds: “We expect the markets to greet this news positively even though, with unemployment close to 10 per cent, we expect little real substance in the agreement as regards the short-term fiscal stance.”

MUNI-DEFAULT
While Greek bond yields make it seem like they would probably get a better deal on their debt from a payday loan shark, US municipalities are also struggling to keep up with their monthly repayments. Reports from Jefferson County, Alabama indicate that it is close to defaulting on its $3.2bn of bonds taken out for infrastructure repairs, which would send them down the same path as the Californian Vallejo municipality, which filed for bankruptcy two years ago. And while Jefferson County is one of a number of cities and counties on the Do Not Resuscitate list, ratings agency Moody’s has indicated that if the US government loses its AAA rating, then at least 7,000 municipal debt issuances would also automatically have their ratings downgraded. Moody’s has signalled that, should Congress fail to reach an agreement on the government’s $14.3 trillion debt ceiling, then the AAA US sovereign debt rating will be at risk. This cut would affect $130bn worth of municipal debt, including mortgage-backed securities held by Fannie Mae.

These problems could be the final nail in the coffin for the dollar’s status as a haven currency, already battered by rounds of money printing. Though it is difficult to forecast the outcome of the ugly dog fights between the dollar-sterling and euro-dollar pairs, gold will undoubtedly be driven ever higher as investors seek an alternative to fiat currency.