The U.S.: Markets Wobble On Debt Ceiling/Downgrade Dangers

Markets are shaky as the American political classes show the rest of the world their irresponsibility and inability to see the bigger picture, especially the so-called Tea Party newcomers in the U.S. House of Representatives.

The continuing failure not only to lift the debt ceiling, but to come to a long term spending cut and tax package, is threatening not only the U.S. economy and its weak recovery, but the rest of the world.

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What is worrying markets are the twin questions: what impact will the failure to raise the debt ceiling have? And what impact will the subsequent default and downgrade have?

No one knows what will happen, because the looming problem hasn't been faced before where the country, whose economy is the world's largest, with the most important government bond market around the globe, and the world's reserve currency, deliberately takes action to trigger a debt default and then downgrade in an AAA rating.

The International Monetary Fund warned overnight that the U.S. has to lift its debt ceiling swiftly for the sake of the U.S. and global economy.

The Fund's executive board called on authorities to only gradually reduce spending, to avert "a disruptive loss in fiscal credibility."

"The federal debt ceiling should be raised expeditiously to avoid a severe shock to the U.S. economy and world financial markets," IMF economists said in a report on the U.S. economy.

So it's no wonder that gold jumped sharply yesterday and sharemarkets were rattled, especially in futures trading in Asia where the Dow, S&P 500 and Nasdaq all saw big falls of one percent and even more at times.

European markets opened lower last night, trading down between half and three percent.

US markets weakened as well, closing down as gold rose and oil fell.

Markets across Asia, from Japan to Australia and China fell sharply.

Australia lost more than 1.6 percent in a surprisingly big sell-off, while China’s Shanghai Composite Index fell three percent on the U.S. debt fears and after Saturday’s collision of two high-speed railway trains.

Hong Kong’s Hang Seng Index dropped 0.7 percent, Taiwan’s Taiex lost 0.9 percent, Tokyo's Nikkei dropped 0.8 percent in Tokyo afternoon trading and South Korea’s Kospi traded down one percent.

The euro, the Swiss franc and the Japanese yen bounced around in volatile trading as investors tried to work out who would win and lose in the event of the U.S. defaulting a week from Monday.

The Australian dollar remained above $UAS1.08, but it rose, then fell during a nervy day of trading. (The Australian dollar will likely rise well past $US1.10 if default and downgrade happens).

Gold surged to a record high as Democrats and Republicans failed over the weekend to reach an agreement on raising the federal debt limit, and sort of boost one another.

The Republicans have special responsibility because of the split between the Senate, where a deal seems popular, and the House, where the Republicans, who control the chamber, refuse to accept the need for tax rises, even the removal of loopholes to business and many tax torts for special interests.

Under the American system of government, Congress is responsible for the debts, the spending, and the taxes. They can and should raise and cut and make the laws to fit the needs of the situation.

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The Senate (controlled by the Democrats) wants to cut spending and raise taxes in the ratio of around 66% cuts and one-third higher tax revenues.

So spot gold climbed by 1.4% to $US1624.07 an ounce in Asian trading, then eased to $US1,611.45.

It closed at a record $US1,612.20 in New York this morning.

Electronic futures trading saw Comex gold for August delivery in New York climb to a new high of $US1624.30, the highest ever.

Copper and other commodities weakened, despite the volatile trading in the U.S. currency.

Ratings groups: Moody's Investors Service, Standard & Poor's and Fitch Ratings have said they will cut the U.S.'s top-level credit ranking should failure to raise the debt limit lead to a default.

Standard & Poor's has already said there is a 50-50 chance it would downgrade the U.S. within 90 days, even if the limit is raised.

The agencies (and many others) see the need for a spending reduction policy and action plan as necessary as the higher debt ceiling.

If Fitch, Moody’s or S&P downgrade U.S. debt, cuts in the ratings of mortgage financiers, clearing houses, banks and insurance companies.

U.S. Treasury Secretary Timothy Geithner said on Sunday that the House of Representatives must start deliberations on a debt-limit agreement by Sunday to meet the deadline.

If the debt ceiling isn't raised, the federal government won't be able to pay 44 percent of its bills worth an estimated $134 billion due in August, according to a Bipartisan Policy Center analysis.

Why? The US Government doesn't bring in enough revenue to pay all its bills -- with monthly deficits averaging $125 billion.

And the current $US14.3 trillion debt ceiling means Treasury won't be allowed to borrow new money to make up for the gap between revenue and spending.

Economists say that it wouldn't be a "cut" in spending so much as a postponement. That's because the bills Treasury puts off will have to be paid once the debt ceiling is raised.

But if government spending were to suddenly dry up even for a short while, it could send a ripple through the economy and slow the already weak pace of growth.

And Moody's Investors Service did help confidence levels by cutting its ratings on Greece's foreign and local currency bond ratings by three notches to Ca from Caa1 to reflect the risk of default.

In a statement, Moody's claimed last week's eurozone support package for Greece contains contagion risk for the region.

Under the package, private-sector holders of Greek debt are now "virtually certain to incur credit losses".

Moody's said in a statement that if when the debt exchanges spelled out in the plan happen, Moody's would define them as a default by the Greek government on its public debt.

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