US Republicans take risks with global markets over debt ceiling impasse

It does not inspire much confidence in global financial markets when the US Congress is committed to a long game of chicken before deciding whether the government will be able to continue funding its operations.

But that is the reality. Congress managed to avoid a government shutdown last Friday with about an hour to spare, agreeing to a budget with US$38 billion (Dh139.57bn) in spending cuts.

But for some time it had looked as if congressional Republicans were prepared to delay a budget agreement and cause a shutdown if the group Planned Parenthood continued to receive funds for family planning and women's health screening - a social policy issue with almost no budgetary impact.

Now Congress has until halfway through next month to approve a rise in the federal debt ceiling of $14.3 trillion, or until July if the government moves cash between different accounts to carry on issuing, refinancing and servicing debt.

Again, congressional Republicans say they will not approve a rise without extracting deeper spending cuts and more concessions from Democrats on issues such as abortion, the environment and health care.

With a congressional recess beginning next week, another 11th-hour staring match looks likely, but this time the stakes are far higher.

The worst possible consequence of not increasing the debt ceiling would be the US government defaulting on debt. That could cause another credit crisis, a crash in global investor confidence, a rise in interest rates, shortage of liquidity and destruction of the fragile recovery in many western nations.

That scenario seems unlikely. For all of the political posturing, the federal debt ceiling will still have to be raised, even if Republican plan to cut $6tn from the budget over the next 10 years was put in place.

The Republicans backed by the Tea Party in Congress want to be seen as making a stand but their leadership will not want to be responsible for setting off a global debt crisis. But even if Congress does come to an agreement and votes to increase the ceiling over the next few weeks, a stand-off between Republicans and Democrats in the interim could be enough to rattle international financial markets further.

Worries about the US treasuries market are already rife given the Fed's $600bn quantitative easing programme to buy back Treasury bonds, improve liquidity and keep interest rates low ends this June.

Fearing the possibility of a new and potentially catastrophic market disruption, executives from the largest banks are already urging the Republican House speaker, John Boehner, and other members of Congress to lift the debt maximum.

Pimco, the world's largest bond fund, already has a short position in US government debt and it is not the only one. The latest quarterly Investment Manager Outlook survey from Russell Investments shows 29 per cent of managers are reducing their exposure to US treasuries.

As the former US Treasury chief restructuring officer Jim Millstein pointed out on CNBC this week: "It's not just the Chinese and Japanese bondholders who hold our treasuries, it's pension funds and insurance companies and banks, money markets and mutual funds."

Mr Millstein said if the US did default on its debt, the Lehman Brothers bankruptcy "would look like a walk in the park on a sunny day. They [the US Congress] are really playing with fire".

Republicans are not the only guilty party when it comes to objecting to debt limit increases in opposition. Barack Obama, the president, voted against raising it when he was a senator and George W Bush was president. The increase was eventually approved by the Republican Congress.

But this time the economic landscape is dramatically different. The economy is inching its way out of a recession and already skittish treasury investors have even more cause for alarm.

Congressional Republicans may be looking for ways to save the economy by pulling back spending but their continued intransigence over the federal debt ceiling could hit global financial confidence hard.

That will only make the US economic outlook worse.