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Archives: A U.S. default is unlikely in the short term

Originally published in July 2011
Simon Nguyen

COMMENTARY | The White House and U.S. Congress are racing time to come up with a debt limit compromise before the August 2nd deadline. Even as progress on a possible deal has somewhat stalled, all signs are still pointing to the debt limit being raised. Even if the debt limit is not raised, the U.S. is the one country in the world that could afford that option and still avoid default.

In spite of the constant partisan fighting in Washington, U.S. lawmakers have time and again succeeded in reaching last-minute compromises to avert potential crises. In 2008, the U.S. congress overrode objections from a number of GOP lawmakers to authorize a $700 billion bailout of financial institutions. Both the 2009 stimulus package and 2010 Bush tax cut extension were met with fierce congressional resistance, but they reached President Obama’s desk anyway. There is no reason to expect something different this time around.

Even if the U.S. congress fails to raise the debt ceiling by the deadline, a default remains an unlikely outcome as the U.S. is backed by two of the world’s most powerful financial institutions – the U.S. Treasury and Federal Reserve. The deadline to raise the debt limit was actually May 16, but the U.S. Treasury was able to move it to August 2. According to Bloomberg, the department has enough assets to extend the deadline even further.

In the unlikelihood that the U.S. congress fails to raise the debt limit, the Federal Reserve could step in as the lender of last resort to avert a possible default. The Fed is already the biggest holder of U.S. debt, ranking ahead of China and Japan. If needed, there is no reason why the Federal Reserve won't roll out another round or two of monetary stimulus to help save the U.S. economy. Since foreign holders of U.S. debt seem to care more about whether America will raise its debt ceiling than the country’s lax monetary policy, there won’t be much protest over such maneuver.

While a U.S. default is doubtful in the short term, it is a different story in the long run. There will come a point where other countries will lose their appetite for U.S. debts. A failure to increase the debt ceiling will give foreign creditors an excuse to shift their investment elsewhere. This will severely damage U.S. credit rating, leading an eventual default in the future.

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