Saturday, July 30, 2011

Countdown to Extinction, Part 2: What They're Doing About It and What It Means For Us

The short term solution to this predicament is for the US to borrow more; the problem is that additional debt would push borrowing beyond the current debt ceiling or limit of US$ 14.3 trillion, and the only workaround is to legislate an increase in the debt ceiling. To improve the US's financial situation in the medium to long term, spending cuts and/or tax increases would also have to be enacted by Congress. Seems straightforward enough, right? So why have these things not been done yet? Two words: partisan politics. The only way a solution could be legislated is if Democrats and Republicans work together and agree on a solution; unfortunately, to this date, the two parties continue to bicker, pontificate, push for their own agendas and refuse to compromise.

As the deadline draws near and an agreement still nowhere in sight, many of us rightfully wonder what this might mean for us, both as investors and ordinary Filipinos. Might as we want to believe that we are immune to the effects of the stupidity of *some* Americans, the 2008 financial crisis has shown us that we are not. I repeat here some of the ways I think we could be affected by a US default that I have already stated in the comments section of the previous post.
  • A default would trigger a rating downgrade on US debt, and this will raise interest rates on future borrowings. I've read somewhere that a 1% increase in interest rate will result in an additional US$ 100 billion in interest payments; this additional financial strain could trigger a recession/depression in the US. 
  • The US is our number one trading partner; a decline in US demand due to the contraction of their economy will lead to a drop in our exports to the US, and this, in turn, will negatively affect both our general economy and the revenues of specific export-reliant industries and firms. 
  • US demand for services in the Philippines will decline and related industries like call centers will also be hit.
  • As soon as the phrase "financial crisis" gets out to mainstream media, people will start to panic and take their money out of the stock market, causing a substantial drop in stock prices.
Given these dire possible effects of a US default on our economy, how concerned should we be? Is now the time to panic? The consensus that a US default would lead to disastrous global economic consequences is matched only by the widespread agreement that a US default will not happen and that eventually these stubborn US representatives will realize the folly of their actions and finally act for the interests of their constituents, as they should have done from the very beginning. Everyone is saying that one way or another, the US government will not default on its debt, so there's no real reason to panic. But that doesn't mean that we should not prepare ourselves for what could happen.

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