The real sovereign debt crisis

For the last few months, bond markets have been spooked by sovereign debt woes in the peripheral countries of the Eurozone: first Greece, then Ireland, and perhaps soon Portugal and Spain. Even founder members of the EU such as Belgium and Italy have seen markets taking a more cautious approach to their debts, if credit default swap (CDS) rates are anything to go by.

This is all scary enough, but the elephant in the room, the really big kahuna, is....the United States. The US federal government, unusually or indeed uniquely, is always subject to a borrowing ceiling, which has to be approved by Congress. The current ceiling is USD 14.3 trillion, and with current borrowing heading towards $14 trillion, the Government expects to use up its remaining "headroom" of about $335 billion by the end of March. At which point, notionally, the US government starts to close down, and could even default. You can read the story on Reuters, and there's a good potted history of the debt ceiling on Slate.

We've been here before, in political circumstances similar to today's. In 1995 the Clinton administration needed to hike the debt ceiling, but Congress was in Republican hands, under the hard-line leadership of the irascible Newt Gingrich. Newt pushed the process all the way to the precipice, and a partial shutdown of the US government had begun before a deal was finally struck.

For the past several years the annual increase in the debt ceiling has been a non-event, because Congress agreed to tack it onto the annual budget bill. However, the new Republican majority in the House has quickly adopted procedural rules that make this impossible, so this year's increase will have to be specifically approved. The Republicans are determined to extract their pound of flesh in return, and have already begun to introduce proposals for spending cuts. The Obama administration is responding with proposed cuts of its own, including a huge slice out of the military budget, which of course the Republicans would prefer to leave untouched.

The new Republican House Speaker, John Boehner (he pronounces it Bayner -- well, you would, wouldn't you?) insists that his party has no wish to shut the government down, and other senior GOP congressmen agree. However, they have to be wary of the assorted right wing kooks and ideologues who have just arrived in Congress with the support of the Tea Party movement. Their willingness to compromise with the Obama administration on even the most trivial matter -- which this, assuredly, is not --must be seriously in doubt.

None of this would matter to the rest of us if Americans were just arguing about reneging on their IOUs to each other. But of course, the US is the world's biggest international debtor. If the debt ceiling isn't raised, Uncle Sam may be faced with stiffing the international creditors who have underwritten its standard of living for the past couple of decades. The consequences for international relations and for the global financial system can only be imagined, but to be sure, it would all make the problems in Ireland and Greece look like, well, a tea party.