Crossroads (Toward Philippine economic and social progress)
Philippine Star, 16 October 2013


The US economy being so big, the world economy is highly dependent on it – its actions and inactions. The current debt ceiling issue mandating the limit of government debt illustrates this pointedly.

Based on US government projections, by Oct. 17, 2013, the debt ceiling allowed by the present law – $16.7 trillion – will be exceeded. Thus, if the authority is not revised upward, the US government will not have sufficient appropriation to pay the debt and will go into default. (This article goes to print on Oct. 16, 2013, the last day before the US debt ceiling is breached.)

The debt ceiling political brinksmanship. The debt ceiling issue in the US is a unique outcome of its political system: the co-equal status of leadership (the presidency) and the legislature (Congress) which operates on the basis of “check and balance.”

If the US political system were a “parliamentary system” in which the leadership of government (the presidency) is integrated with control of the government by the victorious political party, this problem would not occur. The president would be able to carry the vote and adjust the budgetary authorizations. Otherwise, the president could lose his government control through a confidence vote and the government would fall.

So, the political brinksmanship of check and balance invites risky behavior like the tendency for political suicide when the parliament and the presidency are poles apart. It is like the gunfight duel at OK Corral, the American Western movie version of do or die.

The US debt as an international problem. The world is so linked to the US economy that any adverse economic change or lack of certainty that happens on American soil brings with it some unwelcome reverberations on the economic affairs of other countries.

The uncertainty of the debt ceiling issue has brought extra volatility to the world’s financial markets when they are already by nature volatile. This explains why the talk in Washington DC during the annual meeting of the World Bank-IMF (last week) was all about the US debt problem.

As Christine Laggard, the managing director of the IMF aptly pointed out recently, “The world’s economy is vastly interconnected.” The Central Bank Governor of India further aptly said, “Financial markets are very fragile, and we do not need further uncertainty.” The Swedish finance minister talked of the “collateral damage on the world economy” if this issue is not resolved. These were some interview clips from CNN.

The Japanese Finance minister (Taro Aso) said it in more direct language (according to Reuters): “The US must avoid a situation where it cannot pay, and its triple-A [credit rating] plunges all of a sudden…. The US must be fully aware that if that happens, [it] would fall into fiscal crisis.”

China’s comments referred to national interest. The vice-finance minister (Zhu Guangyu) was reported to have said (according to Reuters), in conveying China’s position to US authorities that the latter should take steps to prevent default “to ensure the safety of Chinese investments in the United States and the global economy.”

The more a country is linked to world trade and to world markets for factors of production – especially capital flows – the greater is the potential impact of the US debt problem on the country. This does not need to arise out of direct trade or economic relations with the US economy.

If the country trades with Japan, with China, or with any major European economic power, then that linkage of dependence is established. For all these big economies are tied with the US economy.

Who finances the US debt. More than one-half of the US federal debt – close to 60 percent – is held officially by other governments! According to the US Treasury, China owns $1.28 trillion and Japan $1.14 trillion. These two countries hold around 42 percent of US debt. Another 29 percent is held by other countries, with Brazil, the United Kingdom, and some Middle Eastern countries contributing sizeable chunks.

The Bangko Sentral ng Pilipinas also holds US dollar debt instruments as part of its reserve assets. I do not have the current figures but as recently as a year ago this was in the order of $23 billion, representing a third of the country’s international reserve assets.

Why have these happened? This is because the US economy is important to these countries. Despite its weakened currency, the US dollar has been the safest currency to hold, until now! It will continue to do so, if the US economy remains as important to the world.

This dependence is related to any country that is open to world trade and to capital flows. The US debt is partly the link in this dependence through the acquisition of US dollar assets to prop up the country’s international reserves portfolio. Despite it all, the US dollar remains a safe-haven investment for most countries.

Fragile world economy. The world economy is still in weak shape. The US economic recovery has not been strong. Were it not for the quantitative easing (QE) policy of the US central bank which allowed monetary expansion through the purchase of private sector bonds – a move that substituted for fiscal inaction that failed to support the fiscal stimulus to the US economy – the US private economic recovery would have faltered.

But the US debt limit problem threatens the world’s economic recovery problem. First, it could scuttle the US recovery because any US debt default messes up financial confidence in the world’s biggest economy, and world demand for goods could fall as a result. The world’s economic recovery is in part dependent on how the US economy restores world demand by bringing itself up from the doldrums.

Second, any US default on its debt could surely spell financial disaster on its citizens and enterprises that hold US debt instruments. This is a new disaster for the US domestic economy after the 2008 recession.

Third, it could lead to a downward financial spiral for the countries holding US debt. This means the economies of China, Japan in East Asia and Europe which is hardly emerging from the euro crisis will be hampered.