Paul Krugman's view on the issue...
What a US government default could mean
This may be the way the world ends — not with a bang but with a temper tantrum.
Okay, a temporary government shutdown in the United States — which became almost inevitable after Sunday’s House vote to provide government funding only on unacceptable conditions — wouldn’t be the end of the world.
But a US government default, which will happen unless Congress raises the debt ceiling soon, might cause financial catastrophe. Unfortunately, many Republicans either don’t understand this or don’t care.
Let’s talk first about the economics.
After the government shutdowns of 1995 and 1996, many observers concluded that such events, while clearly bad, aren’t catastrophes: Essential services continue and the result is a major nuisance but no lasting harm. That’s still partly true, but it’s important to note that the Clinton-era shutdowns took place against the background of a booming economy.
Today, we have a weak economy, with falling government spending one main cause of that weakness. A shutdown would amount to a further economic hit, which could become a big deal if it went on for a long time.
Still, a government shutdown looks benign compared with the possibility that Congress might refuse to raise the debt ceiling.
First of all, hitting the ceiling would force a huge, immediate spending cut, almost surely pushing America back into recession.
Beyond that, failure to raise the ceiling would mean missed payments on existing US government debt. And that might have terrifying consequences.
Why? Financial markets have long treated US bonds as the ultimate safe asset; the assumption that America will always honour its debts is the bedrock on which the world financial system rests.
In particular, Treasury bills — short-term US bonds — are what investors demand when they want absolutely solid collateral against loans. Treasury bills are so essential for this role that in times of severe stress they sometimes pay slightly negative interest rates, that is, they’re treated as being better than cash.
Now, suppose it became clear that US bonds weren’t safe, that America couldn’t be counted on to honour its debts after all. Suddenly, the whole system would be disrupted.
Maybe, if we were lucky, financial institutions would quickly cobble together alternative arrangements. But it looks quite possible that default would create a huge financial crisis, dwarfing the crisis set off by the failure of Lehman Brothers five years ago.
No sane political system would run this kind of risk.
But we don’t have a sane political system; we have a system in which a substantial number of Republicans believe that they can force President Barack Obama to cancel health reform by threatening a government shutdown, a debt default, or both — and in which Republican leaders who know better are afraid to level with the party’s delusional wing.
Reasonable people know that Mr Obama can’t and won’t let himself be blackmailed in this way, and not just because health reform is his key policy legacy. After all, once he starts making concessions to people who threaten to blow up the world economy unless they get what they want, he might as well tear up the constitution.
ABOUT THE AUTHOR:
Paul Krugman is Professor of Economics and International Affairs at the Woodrow Wilson School of Public and International Affairs at Princeton University. This is abridged from a longer commentary.
http://www.todayonline.com/world/america...could-mean
