Mike Callaghan is director of the Lowy Institute's G20 Studies Centre.
Will the US Congress fail to increase the debt ceiling and force the US government to default on its debts? The generally accepted view seems to be 'no'.
Most people believe sense will prevail and the debt ceiling will be raised. Why? Because not to do so would unleash 'a weapon of mass financial destruction', as termed by Ken Rogoff.
The consequence of a US default has been described by the US Treasury as 'catastrophic' and would precipitate another financial crisis that would put the US back in a deep economic hole. Bloomberg headlines warned that a default would cause an 'economic calamity like none the world has seen', while Warren Buffet said the US will 'go right up to the point of extreme idiocy, but we won't cross it'.
But if the consequences of a threat are so great that no-one believes the US would go through with it, what sort of threat is it? Answer: a very dangerous one, because mistakes and miscalculations can happen.
Notwithstanding the claims of the disastrous consequences of default, markets continue to take it in their stride. While they may be getting a bit nervous, overall they believe the ceiling will be increased. The price of buying insurance against a default has recently increased, but it is not nearly as high as it was in 2011, the last time the US came close to breaking its debt limit.
The threat not to raise the debt ceiling seems to have lost its bite, at least as far as the markets are concerned. This means that the market is not putting pressure on Congress to reach a deal. As noted in the New York Times, 'the market's reaction – or lack of one in this case – may actually contribute to an outcome everyone has been railing against.'
When playing chicken, one party has to blink if the disaster is to be avoided. In previous stand-offs over the debt ceiling, President Obama has blinked, believing he would bear most of the blame of the consequences of a default, particularly when he was facing a re-election.
But he is in his final term and concerned about his legacy, particularly the future of Obamacare. He may well take the similar view to the markets — that Republicans will not bring the US economy to a possible catastrophe — and seek to force his Republican opponents to move. President Obama has declared that he will not be blackmailed and will not negotiate until Washington is re-opened and the debt ceiling increased.
The problem with this strategy is that it only works if the Republicans believe that the consequences of a default on US government liabilities will be a catastrophe and when put to the test, they will blink.
However, the concern is that some Republicans in Congress seem to believe that the debt ceiling is no big deal. For example, Republican Congressman Ted Yoho argues that reaching the debt limit could help the US economy by showing to the world that the US is serious about its debt problems. Others claim that 17 October is not a fixed date in terms of breaching the ceiling and the US Treasury has wriggle room and can prioritise payments on outstanding debts at the expense of other payments. But as the US Treasury has pointed out, prioritising payments on the national debt above other legal obligations is simply default by another name.
If one party believes that the consequence of a default is manageable, it is less likely they will be prepared to compromise and end the stand-off.
It now appears that both sides may blink and agree to a short-term increase in the debt ceiling. This is certainly better than default, but it will only be a temporary reprieve and we will shortly go through the stand-off over increasing the limit again.
As noted, the problem with these repeated debt ceiling crises is that people become sanitised to the threat, believing it will not be carried out, which in turn raises the possibility that neither party will compromise in the future and the 'weapon of mass financial destruction' may be unleashed.
Are claims of a catastrophe if the US defaults on its debt overblown?
Neither the US nor the world can afford to put to the test the implications of a default in the government debt by the world's reserve currency. The implications would go beyond creating chaos in financial markets. It would accelerate the decline in the role of the US in the global economy as well as its global political influence. The stakes are high in the game of brinkmanship in Washington, not only for the US but for the world.
Photo by Flickr user aficadunc.