The terrible reality of a US default

Failure to reach a deal to raise the US debt limit may force President Barack Obama to choose between paying Chinese bondholders or American soldiers, and between Iowa farmers or elderly Social Security recipients. Those are among the dilemmas Obama may confront should talks with Republicans founder and the government falls short of funds needed to pay its bills. Other choices would include whether to sell at cut-rate prices financial assets such as gold in Fort Knox or loan portfolios acquired through the bank bailout, to avoid default and keep government services going. Even if full payments are made to bondholders, interest rates on US debt may still rise, setting off ripples through the financial world that would drive up costs for other borrowers and impede economic growth, said bond traders. \"Stopgap measures such as picking and choosing which programmes to support would almost be as bad as default itself,\" said Christian Cooper, head of US dollar derivatives trading in New York at Jefferies Group Inc., one of 20 primary dealers that trades with the Federal Reserve. While House Speaker John Boehner and other Republicans say the US Treasury\'s August 2 deadline for when its borrowing authority will reach its limit is artificial, economists and former government officials say those are the types of questions the Obama administration will face if no accord is reached. \"It\'s a real deadline,\" said Jay Powell, a former Treasury undersecretary for President George H.W. Bush. \"Could you live through that for a month? Theoretically, you could. It would be very chaotic. It would hurt the economy.\" Yet the Treasury Department says it will exhaust a series of \"extraordinary measures\" in managing government finances to avoid exceeding the limit on August 2. And without authority to borrow additional funds, the federal government\'s day-to-day income from taxes and other revenue would only cover 56 per cent of projected expenses for the remainder of August, according to a study by the Bipartisan Policy Centre in Washington, where Powell is a visiting scholar. Since Congress already has legally obligated all the government spending, Treasury Secretary Timothy Geithner would be left to pick which bills are paid and which are delayed. The Congressional Research Service said in a report last month that one precedent the White House might follow is focusing first on maintaining essential services such as the military, law enforcement and air traffic control as it did in the mid-1990s government shutdowns. Under one scenario developed by the Bipartisan Policy Centre, the federal government would be able to use its projected $172 billion (Dh631.7 billion) in income to meet its $29 billion in interest payments in August along with Social Security, Medicare and unemployment benefits and payments to defence contractors, if it ceased all other functions. As a consequence, under that scenario, the military and civilian federal workers wouldn\'t be paid, IRS refunds wouldn\'t go out, and veterans wouldn\'t get benefits. A report by George Mason University\'s Mercatus Centre cited by some Republican members of Congress estimated the federal government has $2.4 trillion in assets such as gold, currency reserves and loan portfolios that could be sold to private investors to temporarily make up the funding shortfall for months. Mary J. Miller, assistant Treasury secretary for fin-ancial markets, rejected the idea in a May 6 statement as a \"fire sale\" of financial assets that \"would be damaging to the economy, taxpayers, and financial markets.\" Even so, Veronique de Rugy, a senior research fellow at Mercatus and co-author of the report, said asset sales would be preferable to the consequences of a default that the Obama administration holds out as the inevitable result of failure to meet the deadline. She cites a rush sale of equity investments held by the Treasury Department\'s Troubled Asset Relief Programme that Mercatus valued at $142.5 billion as of September 30, 2010. \"Let\'s say people who would buy these assets know we are in a hurry and play hardball, maybe give us $50 billion. Well, better than defaulting,\" de Rugy said. Some Democrats in Congress also have discussed the idea of claiming presidential authority to continue borrowing without congressional approval based on an interpretation of the Constitution\'s 14th Amendment. A provision originally passed to prevent Southern sympathisers from later repudiating the federal government\'s Civil War debt declares the \"validity\" of US government debt \"shall not be questioned.\" Senator Charles Schumer of New York, the chamber\'s third-ranking Democrat, told reporters last week the issue is \"worth exploring,\" though \"you wouldn\'t want to just go ahead and issue the debt and then have one of the courts reverse it.\" Cooper, of the Jefferies Group, said either issuing debt under such an untested legal theory or financing the government with unusual asset sales would risk raising investor anxiety and increasing interest rates. President Barack Obama was yesterday scheduled to meet congressional leaders from both parties to negotiate an increase in the nation\'s $14.3 trillion(Dh52.5 trillion) legal debt ceiling. Obama is open to a long-term deal to tackle the country\'s finances, although he and other Democrats say an agreement must include revenue increases. John Boehner, Speaker of the House, says any plan that calls for higher taxes wouldn\'t pass Congress. The administration has resisted offering any guidance on how the Treasury Department would respond should the talks fail. David Plouffe, Obama\'s chief political adviser at the White House, dismissed as \"inconceivable\" the idea that the government would choose between paying investors and soldiers. From / Gulf News