The Countdown has Begun - opinion

23 May, 02:37 PM
Federal Reserve System headquarters (Photo:Wikipedia)

Federal Reserve System headquarters (Photo:Wikipedia)

It is worth preparing for the fact that the next two weeks will be roasting, and most likely financial markets will experience a fever. Why?

Inflation has been the main topic of global financial and economic discussions over the past year. Everyone has been talking about uncontrolled price increases, reminiscent of the 17-year era of "Great Inflation," and painting apocalyptic pictures of the future, warning that the fight against rising prices could end in an economic downturn. However, central banks are doing their job well: inflation has begun to slow down little by little, and the economies of developed countries are holding up for now. And just when everything seemed to have stabilized more or less, a new problem arose that threatens to be an absolute catastrophe for the US economy and global financial markets. The problem is called default, and it is not somewhere in Argentina or Lebanon, which are accustomed to this, but in the United States of America itself.

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The point is that the US government, which is used to living in debt, can no longer have the right to borrow. This is not allowed by the law that sets the upper limit of the national debt. It currently stands at $31.4 trillion, and it was reached as early as January of this year. This was immediately announced by the US Treasury Secretary Janet Yellen, warning that there is money in the treasury, but it will only last until the summer. Legislators listened, nodded their heads, but since then, they have done nothing about it - the "ceiling" remained where it was. Therefore, the Treasury cannot borrow, and the money for maintaining the state and servicing old debts is spent from existing reserves, which are slowly dwindling. And it looks like the spring sun has melted them. A few weeks ago, Secretary Yellen again addressed the US Congress, calling for a resolution and warning that there is very little time left - until June 1st. If the "ceiling" is not raised by the summer, there is only one way out - default. So, as we can see, the countdown has begun.

What does default mean? At the end of April, the US Treasury held just over three hundred billion dollars. Every day there is less because it is not allowed to borrow by law and can only rely on tax receipts, which are insufficient to maintain the country and pay for previous debts. Therefore, someone will have to go unpaid somewhere. The consequences of such actions will be significant. None of them will be good. All federal payments, including pensions, social and medical assistance, and state program funding, will be reduced. Government employees will begin to be laid off. Theoretically, transportation management, customs, and other institutions that ensure the country's livelihood may cease to operate. Assistance to Ukraine may also be reduced.

A real storm will begin in financial markets. Almost 70% of US government debt is raised through bonds, owned mainly by the Federal Reserve, pension funds, American banks, and ordinary citizens. A third of all bonds are owned by foreign countries, with Japan, China, and the United Kingdom being the largest creditors of the United States. Therefore, if debt servicing and repayment are terminated, which may happen as early as June, not only will Americans suffer – the wave will affect the whole world. But that's not all yet...

This is especially true now as Trump, who has presidential ambitions, is "playing" for the Republicans.

For a long time, US bonds have been considered risk-free assets, and their price forms the basis for calculating the value of almost all financial instruments globally. However, in the event of a default, the system will simply collapse, and what was considered safe from a financial point of view yesterday will become risky. And the higher the risk, the higher the cost of borrowing. Therefore, the conclusion that financial resources will become significantly more expensive worldwide suggests itself. Expensive capital will lead to a slowdown in the economy, a decrease in the profitability of companies, unemployment, and so on – the list is long and gloomy.

How to fix the situation? It's straightforward since potential default is more than just an economic problem like in Argentina. The US remains the world's most powerful economy and will find money to service its debt. But there is a law, and it must be enforced. For the US to be able to raise new debt, a united decision of Republicans and Democrats is needed as none of the parties currently have the necessary voting majority. Everyone understands that the ceiling needs to be raised because there will be no winners in case of default, but in the current situation, each party is trying to achieve its own goals. At the end of April, the Republicans agreed to raise the existing limit by one and a half trillion dollars while demanding that budget expenditures be reduced to 2022 levels. The lower house of Congress supported this proposal, but there may be problems with its passage in the Senate, as the majority there belongs to the Democrats. For them, expenditure cuts on the eve of elections are not the best option.

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Why does history demonstrate? Since adopting the debt ceiling law in 1917, it has been raised about a hundred times under every American president. Since 1960 it has been raised 78 times. The process was almost always accompanied by political battles, which usually lasted until the last minute before the default was announced. Therefore, the hope that a decision will eventually be found exists, but it is more likely to happen at the last minute. This is especially true now as Trump, who has presidential ambitions, is "playing" for the Republicans. He is offended by the current government and is prone to "cowboy" actions.

So, without losing optimism, it is worth preparing for how the next two weeks will be hot, and most likely financial markets will be feverish. The first swallows have already flown: the yield of bonds due in June, which may become the first victims of a possible default. They have already risen to 5.7%; in April, they were at 3.5-4%. Stock markets will most likely also react to the fall, along with all other financial market segments. Evaluating the situation, investors are preparing for battle, and in this regard, JP Morgan is a demonstrative example. They have decided to create an operational headquarters of top managers of the bank, which will meet every day, and closer to the end of the month and three times a day, to track the situation and, if necessary, make quick decisions. As we can see, the situation is worrying. However, we still hope that common sense will prevail over political intrigue and that the problem with the "Debt Star" will eventually be resolved. This is important for you and me because, on the balance of the scales, this will affect not only our bank accounts but actual aid to protect Ukraine. We really don't want anything to hinder our survival.

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