Saturday, June 11, 2011

US "Default" and Europe

John Quiggin has an interesting piece today on the impending US sovereign debt "default":

The problem is not so much “can’t pay” but “won’t pay”....More importantly, the US government isn’t “other governments”. The ratings agencies are US firms operating in a US political context, and their actions will be governed by a mixture of concerns, starting with self-preservation, but also including a desire to influence US policy in a way favorable to bondholders as a group. In the medium term, that means support for a rapid return to budget balance or surplus, ideally through cuts in spending on the poor and middle class, but including tax increases if necessary. (emphasis added)


In other words, the ratings agencies will participate in the political Kabuki mounted by the Republicans in the hope of forcing Obama to do precisely the wrong thing regarding US economic policy. But the question I want to raise is what this will mean for Europe. As Quiggin points out, some institutional bondholders will be forced to sell if US sovereign debt is downgraded, and this will throw markets into a tizzy, even if a compromise is struck in the US within a reasonable period of time. And if no compromise is struck, market turmoil will be even greater. Given the house of cards that European debt structure is at the moment, this might be all it takes to begin a series of other defaults, this time without the scare quotes. Because if the scenario of US "default" is pure political theater, the scenario of Greek, Irish, or Spanish default is not. One might expect European and international authorities to be taking steps to warn US actors of the dangers here. Perhaps they are, but the issue doesn't seem to have much salience in Europe yet, perhaps because Europeans don't understand how insane American political discourse has become since the Tea Party filled the House of Representatives with angry but inexperienced people with limited understanding of the nature of the federal deficit.


It would be the most colossal of political ironies if a sham "default" in the US were to trigger actual financial collapse in Europe, whose ramifications then caused actual damage to the US economy. If this happens, the gods will be laughing, I'm sure, but if they have any decency, their laughter will be mixed with tears.

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