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Thursday, July 28, 2011

United States of America: Beginning of the End?

The US legislative and political process is in deep crisis.

Congress and the White House lack imagination, a sense urgency and most of all the political skills to move the country beyond ideological pettiness and silliness.

I think this NYT Editorial is prophetic. We could be seeing the last days of an empire.

New York Times EDITORIAL
America's Credibility Is at Risk
Published: July 28, 2011

Until this week, Wall Street has shrugged off each new low in the debt-limit debate, confident - in a whistling-past-the-graveyard kind of way - that Washington would raise the debt limit on time.

Many Republican politicians have insisted that the economy and the country could shrug off a default. Up to Wednesday, the most conservative members of the House seemed to be welcoming a default. They refused to support a plan to raise the limit - and impose overly harsh spending cuts - put forward by Speaker John Boehner.

The cost of this fecklessness should now be clear to everyone. The Dow Jones industrial average dropped nearly 200 points on Wednesday and is down 421 points since Friday when Mr. Boehner left President Obama waiting for a phone call that never came about a deal that never closed.

With bond-rating agencies issuing dire warnings, investors have begun to demand higher rates on Treasury bills that come due in August. Prices have surged on credit default swaps, which are used by investors to protect against default and by speculators to bet on the likelihood of default.

On Wednesday, with Mr. Boehner warning his troops to "get your ass in line" to keep things from getting worse, several hard-line members began switching their votes and chances increased that his plan would pass the House. Whether that gets Washington any closer to a tolerable deal isn't clear.

It would be reassuring to chalk up the market volatility to endgame tension. Even if default is avoided, the prolonged stalemate has left the United States vulnerable to losing its AAA credit rating. For credit raters, the issue is political risk - the danger of dysfunctional politics leading to continued fiscal disarray. The risk is especially high if any deal only raises the debt limit until early next year, as called for in the speaker's plan. The potential repercussions of a downgrade include an even larger deficit, as higher interest rates raise borrowing costs for the government, as well as higher borrowing costs for businesses and consumers. As money that might have been spent or invested is instead used to pay debt, the slowing economy would slow even more and joblessness would rise.

The contractionary impact would be amplified because higher interest costs could hit at the same time as stimulus payments wane: Federal unemployment benefits and the payroll tax cut for employees expire at the end of this year. Deep spending cuts that may accompany a deal would add to the distress.

Financial markets could also be roiled by a downgrade, in part, because a drop in the nation's credit rating might trigger payouts on derivatives bets that counterparties would not necessarily be able to meet.

Not least, a downgrade would be a blow to American credibility and prestige, made all the worse for coming so shortly after the made-in-America global financial crisis. As a correspondent for the German newspaper Die Welt wrote a few days ago, "Out of the American 21st-century crisis could come the downfall of the dominant power of the 20th century." That may be overheated. But no one can shrug it off. The markets and the rest of the world are worried, and they should be. We all should be.
Sent from my BlackBerry® smartphone from Zain Kenya

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