Political squabbles bring damage to US dollar strength

IN the US, the bickering over the raising of the debt ceiling is becoming ever more nasty. Democrats and Republicans are in a deadlock over increasing the $14.3 trillion cap on government borrowing. The dispute has got into a predictable rut: Republicans accuse Barack Obama of profligacy, Obama accuses the GOP of pettiness and then the President makes a speech.

This week, the two sides have seen no reason to diverge from this tried and tested formula. Obama has attacked Republican pushes for meaningful cuts to government spending, by branding the plans as “reckless.” GOP house speaker John Boehner hit back, accusing Obama of writing a blank cheque with the nation’s finances. Obama then made a speech.

Ignoring the fact that the US defaulted on its international debt in 1790, on its gold obligations in 1933, and that many states have defaulted since then, Obama said in a speech on Monday night: “Republican House members have essentially said that the only way they’ll vote to prevent America’s first ever default is a agreement on their deep-spending cuts-only approach.”

DEBT PROBLEM DISTRACTIONS
But just how important is the debt ceiling debate? Despite the noise being created by the debt ceiling squabble, in the long term, it is largely a series of straw man arguments, set up for political point scoring. The government hit its debt limit in mid-May, but some fast and loose spending and accounting adjustments, as well as greater than expected tax revenues, have allowed the government to carry on spending. Contrary to some claims, a failure of lawmakers to agree on the government borrowing cap does not automatically spell a 2 August default on US debt. Yes, the US will run out of money allotted to covering its social security outgoings, but if the government were to delay social security and military payroll spending, they might be able to avoid missing a coupon payment on US bonds.

Kully Samra, UK branch director at Charles Schwab, says that, despite the speculation, he doesn’t believe that there is any real risk of default on US federal debt due to not raising the debt ceiling. He sees this view as being confirmed by the continued extremely low yields of Treasury securities, but voices concerns about the deal that may be made in Washington: “It appears highly likely that the agreement will involve at least an agreement to cut spending by approximately the amount of the boost to the debt ceiling – likely somewhere around $2 trillion.” Samra adds: “Spending needs to be cut, but details are important, including the timing of the cuts and whether there’s a bias towards budget gimmickry. If too much cutting is pushed out into future years, any short-term benefits to the recovery would be offset by longer-term continued uncertainty.”

BEARISH RATINGS AGENCIES
However, while the US may avoid default in the short term, the ratings agencies may well spoil their party. According to Gary Jenkins, head of fixed income securities at Evolution Securities, US lawmakers have a long way to go to reassure the bond markets: “The numbers now being talked about with regard to reducing the deficit over a period of time do not seem to be in the ballpark required by S&P to avoid a downgrade. If that is indeed the case then we would expect the agency to downgrade the US rating before August is out.”

Moody’s Investors Service has also joined the fray, unhappy with the direction that political discussions are heading. Last week, it placed on review for downgrade Maryland, New Mexico, South Carolina, Tennessee and the Commonwealth of Virginia. This review affects a combined $24bn of general obligations and related debt. Though this threat of downgrade affects municipal debt obligations, the areas of concern are symptomatic of the nation as a whole. The ratings agency outlined the major risk factors to be high federal employment as a percentage of total state employment, federal procurement contracts as a percentage of state gross domestic product, Medicaid as a percentage of total state employment and operating fund balance as a percentage of operating revenue.

DOLLAR IMPLICATIONS
This week, the dollar has been battered down further; its status as a haven currency wiped out by investor concerns about US debt worries and its money printing addiction. As investors seek sanctuary in the Swiss franc, it has gained against all the major currency pairs, hitting new all-time highs against the dollar. As long as US fiscal instability continues, this currency trend shows no sign of abating.

US DEBT | BY NUMBERS

$14.294 trillion – The current US debt ceiling, reached on 16 May

$306.7bn – US outgoing obligations from 3-31 August

$172.4bn – US revenues that the US will receive from 3-31 August

$29bn – Interest rate payments on US Treasury securites due on 15 August

7,000 – the number of municipal bonds that Moody’s ratings agency will automatically downgrade if an agreement on the debt ceiling is not reached

74 – the number of times that the US debt ceiling has been raised since 1962

10 – the number of times that the debt ceiling has been raised since 2001

Source: Bipartisan Policy Center