While most people are either mourning the deaths of the recent earthquake in the Philippines, or being anxious for the unveiling of the new iPad in a week’s time, they become oblivious that the most rational emotion to feel right now is to worry.
Why worry? October 17 is a date that looms, while that may just be another Thursday to some, another payday for most or for an even numerous amount of people, another occasion for them to upload a photo from the past into their social networking accounts, the third Thursday of October bears a more serious connotation than just being another day.
By the end of the day Oct. 17, the U.S. Treasury will max out its ability to borrow money and be left only with the cash on hand to pay bills going forward. This is because the U.S. will reach it’s debt ceiling when the clock turns to midnight on October 18, essentially being unable to secure new loans. This means that October 17 is the date when the United States, the world’s largest economy, fares into uncharted waters and risks an impeding disaster economists call, a ‘default’.
Since their government is still in an impasse because of the shutdown and spending powers are limited with no budget enacted, therefore the United States has to pay their bills with sales from treasury bonds. So what’s a treasury bond you might ask? A treasury bond is like an I.O.U from a national government, whether it may be from the United States or the Philippine government. Buying a treasury bond from the government is essentially lending your money to the government, which they pay off timely with interest, depending on their economic growth. It’s in the same effect as buying shares from a corporation if you may.
However, in order to become fiscally responsible the United States does impose a limit on how much they can borrow; this is called the debt ceiling. Since the shutdown disabled the government from effectively spending their revenues, they can only spend to pay off ‘essential services’ such as health services, military spending and emergency services to name a few, using funds from two different sources: daily tax income and what ever cash they had left from the previous tax year.
The U.S. Treasury Department, which safeguards the United States finances, estimates cash reserves to be at US$30B. This may seem like a huge sum, but bear in mind the size of the United States’ GDP and that amount is actually peanuts. In addition, the country is already facing massive ‘essential’ payouts in the coming weeks. The most sizable include: US$12B to be paid to Social Security benefits on October 23, a much larger US$53B in Healthcare payouts and Military pensions on the 1st of November and a US$6B payout to Treasury bond holders on October 31.
The first two payouts have less serious consequences, the U.S. government can simply choose to postpone such payouts until sufficient funds are in place. However, the third one has a much serious, if not colossal, implication. Since the treasury bonds are loans, failing to pay them will spell out ‘default’.
A default means that the borrower is unable to meet payments. Being unable to pay off credit owed to another party would give the debtor a bad credit rating, since they have a tendency not to pay their dues creditors will be hesitant to lend them money. In other words failing to pay off interest payments would give the US a bad standing, since they failed to make a payment and potential creditors are now aware of that. In simple terms, if a friend of yours was unemployed and asked you to lend him money, knowing that he has no source of income would you expect to see your money back? This is essentially what the default would look like.
The three prominent credit risk ratings agencies in the world are Fitch, Moody’s and Standard and Poor. These three entities give ratings to different national economies assessing how well they can meet payments, and it is these ratings which big-time lenders look at when they attempt to lend governments money. The better the rating, the less the risk the investor faces and therefore they are more willing to lend.
People may be scratching their heads wondering, how did such a wealthy nation get themselves into such mess? The answer is simple, the United States simply abused their credit rating too much that they used money they did not have to fund non-essential things. The U.S. campaigns in Iraq and Afghanistan were both costing the government trillions, the worst part is that it was all on credit. The culture of credit has even seeped deep into American way of living, the 2008 financial crisis proves this. Most people spend money they do not have on things they do not even need, in the end they are left struggling to pay off the credit.
The United States is not alone, European nations also fell into their respective credit holes either in the past or in the present. As the saying goes, spending becomes easier when you use money that isn’t yours. While that may be true, and somewhat amusing, it is no laughing matter what that kind of mentality has brought upon the world. We can only blame human greed and profligacy for this.
The U.S. Treasury bonds have long been deemed ‘risk-free’, this is testament to the superpower reputation the U.S. enjoys, a testament to its’ economic strength. The belief was always that the country would always be able to meet payments, with ease they used to say. Now that perception is as feeble as ever, the United States looks vulnerable. Let this be a lesson, not just for government, but even to ourselves: spend wisely, with money you have and prioritize that which is a necessity. All other spending can be done using what’s left.
Further Reading
http://finance.yahoo.com/blogs/breakout/debt-deadline-approaches-happen-u-defaults-175536720.html
http://www.huffingtonpost.com/howard-schweber/on-october-17-if-congress_b_4100402.html
LOUIE ENCABO.com 