The Upcoming Debt Ceiling Fight in the US and its Implications for the Global Economy

In a previous article, we had discussed how raising the debt ceiling and the associated fights over it between the Republicans and the Democrats in 2011 had nearly led to the US economy defaulting on its debt obligations. The badly fought debt ceiling fight led to the first ever downgrade of the US economy by rating agencies.

If there was a lesson learnt from the debt ceiling fight in 2011, it is that partisanship does not pay and instead, both parties are better off negotiating. This introduction is relevant to this article as there is the prospect of another fight over raising the debt ceiling due in May 2013.

In particular, the issue has been delayed by three months as lawmakers in Congress and the Senate agreed to extend the debt ceiling by three months.

Coupled with the showdown over the budget and the near shutdown of the US government, these serious issues cannot be dealt with in a childish manner. Indeed, the sequester that happened wherein certain government functions were denied funds has already hurt the still struggling US economy.

The debt ceiling showdown that is coming up this month has implications for the global economy as the US is in the enviable position of dealing its debt in its own currency unlike other countries that have to hold dollar denominated debt. This reserve currency status for the Dollar has meant that historically the US has gotten away with printing money whenever it ran short of funds.

Imagine yourself having the luxury of holding debt in paper, which you can print yourself. Naturally, the temptation to print as much as you can is irresistible and this can lead to serious mismanagement of your finances.

Now imagine if you had the option of investing with this paper that you can print yourself or loaning it to your friends. This situation leads to an outcome where it is not your problem how much you print but it is the person who is taking the paper who is having a problem.

Similarly, when the US government through the Federal Reserve prints dollars, the other countries suffer because the excess dollars flood their economies leading to asset bubbles and stock market bubbles.

Considering the fact that the global economy is very integrated, this means that any excessive printing of Dollars by the Federal Reserve leads to global monetary chaos.

The other trend that has been noticeable in recent days has been the huge drop in the price of gold that was always seen as a safe asset.

The price drop has been attributed to the fact that the Federal Reserve wants a strong dollar and hence, it wants to control the price of gold so that the Dollar becomes attractive when compared to gold. This has had repercussions around the globe as many investors had heavily leveraged themselves in gold and silver as a hedge against inflation.

Considering the fact that inflation is created by the excessive printing of money, this leads to a catch 22 situation wherein on one hand, printing of money lead to higher prices and on the other hand, the drop in the price of precious metals robs people of a hedge against inflation.

With this issue being linked to the upcoming showdown over the debt ceiling, the implications for the global economy are astounding.

The only way out of this would be for the US consumers to tone down their consumerism and lead simpler lifestyles instead of being addicted to cheap imports made in China and other Asian countries.

As pointed out elsewhere in other articles, the road ahead for the global economy would be for the US to save more and for China to spend more. Of course, this is not what the policymakers want as their strategy is based on the opposite. It is best to remember that unless painful choices are made by everyone, the current instability in the global economy would continue.

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