Back from the brink

In the US, the debt ceiling agreement averts a crisis and postpones the problem

With the US Senate passing the debt ceiling bill, the government will be able to borrow and function till January 2014. Few people believed that the US government would actually default a delay in payment is technically a default but even the tiny probability that it would do so was scary. A few days of delay in interest payments would have been enough to cause huge volatility in bond prices. The large number of central banks, such as those in China, India and Japan, which hold the supposedly risk-free bonds of the US government, might have started adjusting their portfolios to exit such bonds.

The main issue of contention was the Obamacare health plan, which is being strongly opposed by some Republicans. That issue has not been resolved. The general sense in the US and in financial markets was that an agreement would be reached before the last day, at the eleventh hour, and that the shutdown was disruptive and unnecessary, leading to difficulties for thousands of employees and loss of income for businesses.

While a crisis has been averted, the problem has been postponed. In three months' time, some of the same discussions may be resumed. While in principle all agree that excessive borrowing is bad, for any individual, household or government, the US government has been able to build up huge debts due to its unique position as the producer of the reserve currency. In all likelihood, the US government will now go back to issuing debt and markets will continue to buy its bonds. Indeed, despite a reduction in its credit rating and the probability of a further downgrade, US bonds remain popular as there are few alternatives for investors. Safe financial assets for the world's ageing population are rare. Similarly, for countries buying some insurance, US treasury bills, with their high liquidity and still low default risk, remain the first choice. This has allowed the US to build up trillions of dollars in debt, and will probably keep allowing it to do so, regardless of the recent episode.

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