Hitting the roof: How Americans got into their debt dilemma

Last autumn, a Tea Party storm engulfed the US with a movement of anti-government, anti-tax politicians sweeping the House of Representatives in the mid-terms and almost giving the Republicans a majority in the Senate. President Obama’s ‘change’ of 2008 was no longer in vogue. However, he weathered that ‘shellacking’ and capped the year with an impressive list of legislative achievements that seemed to render the Tea Party movement a mere fad.

Crucially, however, Obama did not manage to end the Bush-era tax cuts (much to the anger of many Democrats), and the issue has returned to the forefront of the political and economic debate in a big way.

The US needs to raise its $14.3 trillion (£8.9 trillion) debt ceiling by 2 August to avoid a default. However, on the Republican side, such a move without serious spending cuts would be anathema.

Democrats are willing to make some public spending cuts but Obama remains firm that there must be tax increases as well to ensure the country can move forward in tackling its debt.

Bill Kenyon, political director at Strategic Perception, a Republican media consultancy, said: ‘There is a strong sentiment among many Republicans that they lost their way during the Bush years when it came to spending and taxes. As George Bush senior learned, if Republicans can’t be counted on to hold the line on spending and taxes, then they’ve given up one of the strongest reasons people are inclined to support them.’

Credit rating warning

All this political bickering over the debt ceiling and the budget saw Moody’s announce on 14 July that it was reviewing the US’s AAA credit rating, followed the next day by S&P warning there was a 50/50 chance it could cut its rating.

The prospect of the US defaulting is still a long shot. Moody’s warning – along with Federal Reserve chairman Ben Bernanke saying a default would create ‘a huge financial calamity, which in turn would affect everybody and would set job creation back very significantly’ – certainly added an urgency to both sides of the negotiating table.

But the short-term question of the default is not the issue that might concern investors; it is the long-term debt tackling plan. President Obama announced on 14 July that if there was no agreement by 22 July, then the discussion about budget cuts and taxes would be abandoned and the White House would focus solely on raising the debt ceiling.

This concerns Sanjay Joshi, senior portfolio manager at London & Capital, who decried the impasse in Washington as ‘shameful’, accusing politicians of ignoring the 2 August deadline in favour of focusing on presidential primaries.

‘A potential US debt failure,’ he said, ‘is making investors nervous, as seen by volatility levels rising. Yield levels are fluctuating wildly in the two main safe haven markets (US Treasuries and bonds). Investors are increasingly watching with dismay and this dismay has led to gold and silver prices rising dramatically as investors seek some kind of solace.’