Last August, America faced one of the most difficult decisions it has had to make regarding its financial history. Throughout its history, America has had been to wars, faced depression and hardships but never its financial viability had been in question. This security made the country certain and secure in terms of investment and that was why it was always seen as a safe option when investing. In the past, the wars that the country had waged had been financed by a thriving economy and even when it saw through the Great Depression, the country had enough to survive through it. August 2011 saw all of this change. America had posted a budget surplus under Clinton Administration which was turned into a deficit under George Bush’s two terms.
The weight of the two wars in Iraq and Afghanistan and relaxed fiscal policy allowed the administration to run into a deficit hoping that the growth in the economy would continue in the next decade or so. The hubris was soon dealt a heavy blow when the country saw the worst recession which could spawn into another Great Depression. In order to save the economy, the debt ceiling was raised and this further worsened the economic situation of the country. The worst came to head in August when the debt limit was about to be reached. Congress fought over conservative measures from the right against the liberal left and the debate came down to the Republicans holding the legislature and the American nation hostage.
Rounds of negotiations were hard fought and finally led to a deal being made on both sides. The importance of this event has effects all over the finance world as well. Up till then, America was among the few countries which were considered safe and had an A+ rating by all the rating agencies. Debt limit, worsening economy and the political deadlock led to the rating agencies lowering America’s rating. The ripple effect of this was huge. When the debt lowers in rating, America has to pay a higher rate of return to its creditors and then all the products that are indexed to the debt also rise in cost. The end of the event was that the debt limit was increased and the damage that could have had been caused was limited to an extent.
Last Wednesday, the Treasury department has notified that by the end of the year, the debt limit is to be reached again. The debt ceiling is at $16.4 trillion and it is expected that through the use of its funds, the debt limit will not be seen until early 2013. The treasury department has said that it would not default on its obligations and considering the political environment in Washington, any downgrade will be mainly ignored or taken with little consequence so a downgrade is not expected either. Many experts believe that teh US is still an A+ country and that the downgrade, even though it follows the letter of the law but fails to take ‘spirit’ into account.
Another aspect that has to be seen is that whether another raise in debt ceiling would be expected. In the last round, an agreement was reached that in case the limit has to be changed, there would be certain tax hikes and spending cuts that will automatically take place, termed as the fiscal cliff. It has to be seen whether the feud in Capitol Hill passes political spheres into financial ones again and both parties lock heads again this time round. The Treasury is staying on the lines and has given a deadline till the fiscal cliff is reached. It seems that even though the world will have their eyes on the two main contenders on 6 November, there is significance to the smaller elections taking place alongside. There are seats in the Congress up for grabs this year and the composition of the new Congress will determine the nature of the fiscal cliff and the debt ceiling post-election.