Well, I thought that I should pen down some thoughts on this critical issue which is threatening to pull the American economy back into recession.  To begin with, let’s understand some basic concepts that govern the issue at hand. First of all, its important to understand that printing of money in any country is controlled by that country’s Central Bank. Eg. It’s the RBI in India and the Fed in the US. The Central bank has a critical role to play. If they print a lot of money or leave interest rates very low, that would drive up liquidity leading to high inflation. If they do the reverse, inflation might be low but there won’t be enough capital to do business in the country, hence the GDP will go down leading to poorer lifestyles of the masses. Hence, these Central banks have an important role to play as they decide liquidity flow in the country. They act independently and are supposedly run by very competent economists.

The government of a country is like a large organization that spends money for the upliftment of   its people. This money comes either through taxes or by raising debt by issuing bonds. Government spending is very important as it leads to large scale creation of jobs for the masses and also helps people attain better lifestyles. Sometimes, a situation arises when the government runs out of money and in order to meet its spending obligations needs to either raise taxes (which is a politically suicidal move) or raise money through debt. As long as the debt remains within certain limits, borrowing can be a good idea. However, if the debt reaches dangerously high limits, raising more funds through debt can only create a fiscal deficit time bomb waiting to explode.

The US has historically had a certain debt ceiling which the governments have had to adhere to over the years. This ceiling has been raised several times in the last few decades. This ceiling was hit once again earlier this year in May leaving the US government only enough money to pay its bills till Aug 2^nd. The first impulsive reaction anyone would have would be to raise the debt ceiling and borrow more. However, economists have now started to question this logic of constantly raising the debt ceiling as debt levels are already dangerously high. The debt level is currently around 95% of the US GDP. In response to this, there has been relentless bickering between the Republicans and Democrats on what is the best way to address the situation. Broadly speaking, the Democrats favor raising taxes and the Republicans favor cutting government spend apart from raising the debt ceiling. As a result of this impasse and failure to come to an agreement, the debt ceiling still remains where it is with Aug 2^nd agonizingly close. If an agreement is not reached, the US government will default on its payments.

Some of the payments that would be impacted would be Social security checks and salaries being paid to millions of government employees and armed forces. Most government spending projects also would come to a standstill. The domino effect of this would be tremendous. When government spending would stop, unemployment would rise. People dependent on social security checks would not be able to pay for their services and supplies as well as mortgages/loans, thereby impacting banks. Lesser spend would mean lesser revenue for the economy and consequentially lesser profits. The stock market will tank 20-30%. GDP growth would slow down threatening to pull the economy into a double dip recession. Printing money is out of question as that decision is taken by the central bank which maintains a delicate balance of money supply. Any excess money supply would trigger inflation which would actually worsen the situation and would be a whole new problem to tackle. Imagine high unemployment and rising prices!!

More importantly, in my opinion, the damage this would cause to the prestige of the most powerful nation of our times would be immense. The US government would be humbled and flattened by its own mismanagement and political bickering.

The other question that arises is what impact it will have on us in India. It’s hard to imagine that we will go unscathed. It’s obvious that there will be sentimental reactions. The stock markets globally would temporarily fall and India would follow the trend. Gold prices would shoot up(they have already!!) as it would emerge as a safe haven to park money rather than US Treasury bills. If the US goes into another recession, then the laws of economics in an inter-connected world would prevail. There is a strong chance it will negatively impact the Indian GDP too.

So you see, the stakes are very high. In my opinion, this drama will soon end. The US will come up with a temporary fix to the problem to avert the default. But the longer-term question would still remain. Till when can this high debt be sustained and what austerity measures must the US take to restore parity and normalcy? It’s a question that will certainly be in the minds of 330 million Americans and the government will have to soon provide the answer.