Us_Debt_Ceiling

RMIT International University Vietnam ASSIGNMENT COVER PAGE Your assessment will not be accepted unless all fields below are completed Subject Code: | BUSM 3311 | Subject Name: | International Management | Location where you study: | RMIT Vietnam – Hanoi Campus | Title of Assignment: | Literature ReviewTopic: The United States debt ceiling crisis in 2011 | File(s) Submitted | S3177026_Literature review.docx | Student name: | Truong Viet Hung | Student Number: | S3177026 | Student Email Address: | S3177026@rmit.edu.vn | Learning Facilitator in charge: | Mark PeterSon | Assignment due date: | 12th September 2011 | Date of Submission: | 11th September 2011 | Late Submission Approval | NA | Number of pages including this one: (Please number your pages like this: page 1 of 7, page 2 of 7, etc) | 15 | Word Count: (Main Content) | 3026 | The United States debt ceiling crisis in 2011 Table of Contents 1-INTRODUCTION 3 2-THE US DEBT CEILING CRISIS 4 2.1- Definition of debt ceiling 4 2.2- History of the US debt ceiling 4 2.3- The 2011 US debt ceiling crisis 5 3. Further considerations after debt negotiation 7 3.1- Effects in the US 7 3.2- Effects to the world 9 4. Similarities and differences: 10 5. Conclusions 11 6. References 11 1-INTRODUCTION The United States of America (the USA or the US) is among the world’s largest and most powerful national economy. In 2010, according to World Bank’s data, the US economy accounted for approximately a quarter of the world’s total gross domestic product (GDP). Even when other countries was struggling under the time of economic crisis, the US still remained its leading status with GDP of 14.5 trillion (World Bank, 2010), which is nearly seven times the size of UK’s economy and three times China’s. As the US Conference board (as cited in Behr, 2009) indicated, the average American worker’s high productivity is around 20 percent higher than that of the average of many European nations and 85 percent higher than China’s. Therefore, the United States has maintained a stable GDP growth rate with a low unemployment and inflation. The US were regularly ranked the world’s top competitive economies by the annual World Economic Forum (Behr, 2009). However, in spite of being the world’s largest economy since 1980s, the United States economy is currently facing its biggest ever challenge. Domestically, in 2008 the US was stuck into the considered-worst financial crisis and economic downturn since the Great Depression of the 1930s, which could take the country quite a long time to recover. The financial crisis beginning in the US was directly the main reason for the following Great Financial Crisis which proceeded globally in a very complicated way and caused the worldwide destruction to giant established economies such as United Kingdom, EU and so on. Internationally, it is now common knowledge that the United States is no longer the number one economy (Coy, 2006). To make the matter worse, debt ceiling crisis have recently become the US’s most debatable topic, which would bring quite a few implications after a deal was reached that raised the borrowing limit and reduced future government spending. With the United States being the most influential economic power, its financial issues are always in the center of the global attention. That is why the term ‘the US debt ceiling crisis’ has become one of the hottest keywords that attract everyone not only in the US but also around the world. At this writing (September 2011), Mr.Google has produced approximately 19 million results regarding the US debt ceiling issue. What is debt ceiling' Why does the US debt ceiling matter that much' And what are the Americans as well as the world’s reaction toward this crisis' The purpose of this paper is to approach the above questions through economic experts and researchers’ point of view. 2-THE US DEBT CEILING CRISIS 2.1- Definition of debt ceiling According to the United States Treasury Department (n.d.), the debt ceiling, also called the debt limit, is the amount of money set by the Congress and can only be increased with the approvals of both houses of Congress to pay for legal government obligations in terms of securities, social benefits, and national debt and so on. In comparison, Cha (2011) simply considers debt limit as the legal limit on federal government borrowing, which was only approved by the Congress by 1917. Staff (2011) from The Fiscal Time gives a narrower definition stating that it is a fixed cap established by Congress on the debt amount of the government. All above mentioned definitions assure that the debt ceiling is clearly rendered in law and requires both new legislation code by Congress and Obama’s signature in case of any changes. 2.2- History of the US debt ceiling According to Cha (2011), Congress approved directly the amount of borrowed money each time it went up before 1917. In order to more flexibly provide finance demand for the US’s involvement in World War I, in 1917 lawmakers instituted the initiative ‘debt ceiling’ to provide the centralized management support for the majority of borrowing on condition that it keeps the total at or below the authorized ceiling. Staff (2011) adds the fact that the debt limit has been raised 74 times since 1962. While another source indicated that an initial debt limit was set at 11.5 billion and the ceiling has been raised around 100 times since then (Committee for a Responsible Federal Budget, 2011). Recently, in February of 2010, the debt limit was raised by $1.9 trillion to a level of $14.29 trillion US dollar. Figure 1: U.S. debt limit from 1940 to 2010 (US dollar) Source: Congressional Research Service and White House Office of Management and Budget (Table 7.3, Historical Tables) 2.3- The 2011 US debt ceiling crisis a- The debt ceiling raising debate According to Secretary of the Treasury, Timothy Geithner (2011), nearly half of US government spending relied on borrowings. Hence in order to continue current spending levels, the federal government has to raise the debt limit. If not, 40 percent on government spending would have had to be cut immediately and lead to a “catastrophic of economic consequences” on American’s life (U.S. Department of the Treasury, n.d.). Collander(as cited in Berlin, 2011) explains that tax is tightened to debt ceiling, and provide that tax raised to 60% to cover government spending, social benefits will be ongoing paralleling with US expanded loan. This is the fact that both Republican legislators who detained a main part in the House of Representatives/ who held a majority in… and Democrats who win control of the House of Senate agree. The problem is the debt ceiling as mentioned above can only be increased with the approvals of both houses of Congress. However, whilst Democrats are in favor of slimming consumption or hiking taxes, Republicans are “calling for deep and immediate spending cuts” (Saine, 2011). Besides, Tea Party members, most of who are considered to be Republicans, also insist on no increasing debt limit at all (Khan, 2011). Goolsbee, a formerly chairman of the Council of Economic Advisers, warn that it would be “catastrophic” if raising debt limit consensus cannot be reached (Lawder, 2011). Also Senator Lindsey Graham (R-SC), often considered a political bridge-builder, said on Sunday he would link his vote on the debt ceiling to demands to reduce long-term spending obligations, including Social Security (Jacobs & Andrews, 2011). The Republican National Committee's Ken Blackwell argues for legislators to use the pending debt limit vote to push for a balanced budget amendment that would "fundamentally address our nation's addiction to spending indefinitely" (Blackwell, 2011). In brief, the debt debate in fact is the battle between increasing taxation or government spending reduction (Biggs, Hassett& Jensen, 2011). As President Obama said, deal compromise will give an escape from default risk, although it costs much reduction and a lot of efforts. According to Levit et al. (2011), old debt limit may prevent the government from executing its paying obligations. All public services such as social securities, salaries, retirement and unemployment aids, profit from financial funds and maturing securities would vanish from sight. More horribly, US bonds lost credits and many people must start from scratch because a considerable ratio of government consumption would unlikely be payable (Staff, 2011). A large portion of public spending eliminated from the economy would bring serious economic effects, especially in GDP. What is more, the slow payments to public, service providers and common organizations from government also harm these persons and entities as presented in CRS Report for Congress (Levit, et al, 2011). The day April 25, 2011 marked the Treasury Borrowing Advisory Committee‘s worries in form of a letter mentioned to US economy status if debt limit stands still. The committee disclosed some potential repercussions following by the default on US liability composing a rating downgrade, damage to the economic recovery, and other “catastrophic financial situations”. This report also triggers another issue of faith loss of creditors in government when it prolongs the date of interest paid to them. If this suspicion becomes true, the federal’s real rate would even rise more, leading to larger danger to financial markets (Levit et al., 2011). Regarding stock market, the default could eliminate U.S. bonds and many investors' portfolios, as quoted by the former Congressional Budget Director Rudolph Penner. In reality, Sam Stovall, Standard & Poor's analyst warns a drop in daily basis stock market when the problem has not been resolved. Similarly, CFR's Steil saw the crash perspective of collapsed bond and stock markets if no debt limit compromise was reached. b- What is the result of the debt battle' The US government officially hit the debt ceiling of 14.29 trillion dollar on May 16, 2011. On July 31st of 2011 an agreement between Congressional leaders and President Obama to increase debt ceiling and “ cut trillions of dollars in Federal spending over next decades “had been reached(Hulse & Cooper, 2011). The legislation was then passed by both the House and the Senate on August 2nd. President Obama signed the Budget Control Act of 2011 into law on the same day on the date which was estimated by Treasury Secretary Timothy Geithner to be the deadline of the US debt ceiling raising (Murray, 2011). The debt ceiling raised is considered to end the immediate debt crisis but failed to address the “budget chaos reigns” in 2012 and 2013 (Reilly, 2011). 3. Further considerations after debt negotiation 3.1- Effects in the US Obama reaches the debt negotiation on the day August 2nd, but the story does not end here. There remains a mammoth of problems related to politics, economics and finance in this country. Complying with the compromise, US will have to cut down a substantial government spending of $2.5 trillion over a decade. Lam, Zandi (as cited in Reuters bureaus, 2011), Foroohar (2011) and Mallaby (as cited in MacGuineas et al., 2011) together presents concern about the perspective of US economic growth in that period. Firstly, according to Lam (cited in Reuters bureaus, 2011), OSK/DMG, the tightening spending program will lessen only 0.3 % of the economic growth. However, the main consequences do not lie only in such minor number but also in indirect results such as decrease tax for the rich and the same for the poor’s unemployment benefits. Thoma (cited in Reuters bureaus, 2011) says revenue and spending cuts only make the problem worse once unemployment rate is still above 6.0%. In other words, the debt deal requires a considerable amount of spending cuts when consumption should be boosted more than ever. This idea is also shared by Zandi (cited in Reuters bureaus, 2011) who showed concerns about fiscal restraint in the latter 6 months of 2011 as a mistake. Secondly, the deal favors the rich with new taxes applied compared to shrunken unemployment support, public-sector-job cuts and thinner programs giving exits to lay workers, who takes up 95% of the population and 71% of the spending (Foroohar, 2011). Also by Foroohar (2011), this means income inequality may be expanded which is synonymous with another slow-down factor to economic recovery. More specifically, with more money, the rich may buy more luxury items which partly stimulates spending but the overwhelming tendency is still a downward trend due to their possibility to put money in savings. It is the problem of diminishing curve when income concentrates on some small groups of people Finally, some economists caution that now US face to a new hazard of unsustainable dollar currency status. According to CFR's Mallaby (as cited in MacGuineas et al., 2011), this is originated from ceaseless deficits which erodes belief and reduce investor willingness to hold US Bonds or Treasuries. Schoen (2011) supports this idea by mentioning high interest rate’s parallel with a looming economy and no incentives for both investors and workers. On the other hand, Krugman (2011) optimistically states that some measures targeting to encourage employment hiring may produce good result. Another approval voices came from Paulsen (as cited in Reuters bureaus, 2011) and Peterson Institute's Bergsten (cited in MacGuineas et al., 2011) who suggests some correction to preclude this cut-throat rate as well as the unexpected appreciation in dollar’s exchange rate. Soon afterwards, S&P downgrade US’s credit rating from AAA to AA+. It is the first time in the history that US receives such a result and it shocked all the world and the week immediately witnessed unhappy indexes with deep drop in nearly all markets, as Dales says. Yet still no improvements in this index has been recognized so far, which proves a problematic economy with challenges ahead for Obama and his accompanies. As the economist of University of Chicago PhD, Asness cautions that economic instability remains in high level and was underappreciated. MacGuineas of the New America Foundation suggests it is high time to switch from consumption-driven government to one concentrated on sustainable investment whereas Paulsen (as cited in Reuters bureaus, 2011) still expects a bright future in economy with no really big issue. Besides exists a negative look on that change, says Woolfolk (as cited in Reuters bureaus, 2011) who claims they need a “long-term solution put in place” instead. Standing in a neutral position, Grugman argues that the action is “better than nothing”, but harder efforts stay in need. Secondly, this marked point raises a question about US unity in terms of controversial government ability in stimulating the economy. According to Garrett, debt crisis in US should be considered a political crisis relating to the future role of its government rather than a normal fiscal crisis as in Europe. Identically, MacAskill (2011) from The Guardian states that the main problem of US is not only the crisis itself but also the controversy among parties towards the 2012 election. Before the milestone on 2nd August and even afterwards, concerns about the reaction of Washington led to an immense confidence loss in US government,as claim from Bill McInturff(as cited in Balz, 2011) of Public Opinion Strategies. As indicated in his analysis, a strong evidence lies in the result of a poll by The Washington Post (2011) which underlines the shocking intensity of 73 % losing confidence in government stemmed from debt ceiling crisis. 3.2- Effects to the world Right after information about the debt compromise come out on 3rd August, Reuters recorded positive improvements in Asian stock market. Following were Tokyo, Sydney, Hong Kong stock markets at 1,5% rise and European market at 1% growth. However, it did not last long until information about S&P downgrading was revealed 4 days later. As a quick reaction, worries about a global crisis started from US cast shadows of doubt on lots of nations. It cannot be denied that the bold action of S&P is “a big blow to the world confidence” in US power, explains Kuo-yuan of the Taipei-based Polaris Research Institute. Agreeing with him, Levine (2011) states that US need to cope with more daunting obstacles to recover its credits. His works say that China and other Asian countries will reconsider US’s debt rigorously and “unlimited loans” now is the past. According to Roach (2011), Beijing weathers substantially from the downgrading with 60 percent of its foreign currency stored in dollar as the biggest US stock owner, vera discloses the fact that Beijing, albeit generally approve debt ceiling raising as a suitable and timely measure, suspect US ceaseless deficits. Many US’s allies including Japan, South Korea, Taiwan and Australia confirm their belief in US treasury and assure that no serious impact were given from this assessment (Maters,2011). More surprisingly, Grills (cited in Reuters bureaus, 2011) links to a better tone in emerging corporate performance in Argentina and Venezuela in this spectrum. Never before does such a risk of a second recession present clearly to global analyst with numerous of negative news. However, the main problem is not AAA or AA+but is the unpredicted impact that can worsen US related property, slim US debts and revalue assets related to them, writes Professor ShenChung-hua of National Taiwan University's Graduate Institute of Finance. Beacher (as cited in Reuters bureaus, 2011) also meets his fellows in the common idea that solely short term solution can not eliminate the uncertainty in global financial markets, and US downgrading is just the beginning if no more effective plans show up . 4. Similarities and differences: In the literature review, some authors provide information about US debt in 2011 which is very general, but some other seems to investigate and provide very detailed outcome for the similar topics. Lam, Zandi (cited in Reuters bureaus, 2011), Foroohar (2011) and Mallaby together presents concern about the perspective of US economic growth in that period. Besides, according to CFR's Mallaby (2011) this is originated from ceaseless a deficit which erodes belief and reduce investor willingness to hold US Bonds or Treasuries. Schoen (2011) supports this idea by mentioning high interest rate’s parallel with a looming economy and no incentives for both investors and workers. Those ideas seems to be quite general, but some other author like Committee for a Responsible Federal Budget (2011), they have provided very detailed statistic about the debt of US through different years in figure 1 above. Furthermore, some authors seem to be very critical and negative about the US debt. For example, CFR's Mallaby (as cited in MacGuineas et al., 2011), this is originated from ceaseless deficits which erodes belief and reduce investor willingness to hold US Bonds or Treasuries. Schoen (2011) supports this idea by mentioning high interest rate’s parallel with a looming economy and no incentives for both investors and workers. However, other author like Krugman (2011) is very optimistic about that and he states that some measures targeting to encourage employment hiring may produce good result. 5. Conclusions Despite of being the world’s largest economic power, the US has recently facing tremendous financial challenges which require the government’s timely action. Among those is the debt ceiling crisis issue that is still a debate topics until now. Although it was apparent that rejection to raising debt limit would result in a catastrophe risk, US congress’s keeping raising debt limit and lend possibility may still lead to an erosion of confidence in US affordability followed by a rising interest rate. This literature review has based on many facts and figures provided by trustful sources and various views from different experienced economic experts and magazine writers. The US debt ceiling crisis has been solved by the agreement of both Houses to increase the limit. However, as indicated in the Global Competitiveness Report 2011- 2012(n.d.) made by the World Economic Forum, the US continued the declining trend, falling from fourth position last year to the fifth this year due to continued financial vulnerability and persistent high unemployment. 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