New York (CNN) Call it American financial exceptionalism.
The full faith and credit of the US government goes a long way. Really far.
The United States is the best place in the world to park money. The relentless demand for US government debt is keeping interest rates low and making the dollar the world’s reserve currency. And US government bonds are the most attractive investment in the world, allowing you to spend on everything the United States wants, from defense to rights, schools, roads, bridges, technology and Science.
America’s ability to borrow — and its strong reputation for paying it back — is its superpower. And if he doesn’t – for the very first time – that reputation could disappear.
“The United States has the exorbitant privilege” of being the cornerstone of the global financial system. Its ability to borrow is the envy of the world and “it would be foolish to give it up,” said political risk analyst Maximilian Hess, director of Enmetena Advisory, in an interview on CNN’s Early Start. He called the fight over the debt ceiling “irrational” and said it “seriously hurts the United States.”
“America’s ability to borrow is what gives it the ability to apply sanctions,” he said. “That’s what gives it the ability to influence other countries, that’s what gives it the ability to wield so much influence over institutions like the IMF and the World Bank,” Hess said. US borrowing supports “the influence of the dollar in the international economy, and the plumbing of everything from options markets to oil and commodity markets is enormous. And behind it all is a stock of US bonds. U.S. Treasury that are the foundation of the banking and financial system of the world,” he said.
“And by flirting with that flaw, we’re putting all of that at risk.”
The world is watching
From a global perspective, internal party disputes over spending priorities are incredibly myopic.
“If we go too far flirting with her this time, it means that every future crisis will be far more damaging to America’s economy, prestige and future growth,” Hess said.
The whole episode could even increase the costs of financing the debt that Washington is arguing over.
As the Treasury’s cash balance dries up to just $60 billion, there’s a mountain of bonds that will need to be funded when the Treasury’s borrowing machine starts up again – and that’s borrowing that will be more expensive if the fight against the debt ceiling is collapsing further.
“The debt ceiling fiasco, raise your hand if you’re tired of either side using it as leverage in budget negotiations,” wrote Chris Rupkey, chief economist at FwdBonds, in a note to customers. “Markets need to stay alert to Treasury borrowing needs. The numbers ahead are important… We know these are the deepest and most liquid markets in the world, but what if buyers balk to all the new paper the Treasury wants to sell?”
Answer: Bond yields would skyrocket, making borrowing more expensive.
Brinksmanship vs budgetary discipline
Don’t confuse the drama around the debt ceiling with real fiscal discipline. The debt ceiling strategy is the least effective way to deal with debt and deficits.
“Given the strict annual budget processes that are in place, it is not clear that the debt ceiling improves economic and financial governance,” said Mohammed El-Erian, chief economic adviser at Allianz. “On the contrary, it has tended to be used at times to meet short-term political objectives rather than to improve governance.”
With the clock ticking, what has until now been a story about Washington’s infighting and the foundations of the global financial system is about to become a Main Street story.
It all depends on whether a default is short or something even more dangerous.
“In the short term, you can take inspiration from what happened in 2011,” El-Erian said. “The (stock) market is going to correct itself, but it’s going to kind of work its way up and then kind of rebound.”
The S&P 500 fell 15% from July to August 2011, even though Congress finally raised the debt ceiling two days before Treasury funds ran out. “But the real concern is whether it’s going to be long and protracted. That’s where you really get unprecedented downturns. The market could drop over 40%.”