US Debt Crisis- Is Uncle Sam Going Broke??

Thu, Sep 1, 2011

Biz Arena

US Debt Crisis is one of the major news flashing in media and clogging our minds for quite some time now. There were many issues which led to it and there are various possible repercussions to it: the downgrade by Standard & Poors being one of them. This piece is an attempt to chart out the causes that led to the grim situation and possible courses of action.

US Debt Policy: Whenever there is a budget deficit, the US government covers the shortfall by its Treasury.Issue of bonds and other debt instruments to bridge the shortfall is considered routine in US and there are always more than enough people to invest in Federal government. (Remember they were rated AAA). These bonds can be held by banks, corporations and even by foreign countries. However, there is a cap, known as debt ceiling, on the amount government can borrow. First introduced post World War I, this ceiling has been increased 40 times and stood at US$14.294 trillion on April 15, 2011.

US Debt Crisis Time Line

Early 2011: S&P and Moors Credit Rating Agencies warn US of a possible Downgrade.

April, 2011: US Congress Passes the Final Part of Annual Budget with a deficit of $1.65 Trillion

May, 2011: US Debt ceiling of $14.29 Trillion is reached.

June-July, 2011: The house of representatives (Republican Dominated) is unwilling to increase the Debt ceiling without cuts in expenditure

July 2011: US faces a possible default with a deficit of $130 billion on Aug 2, 2011.

July 31, 2011: US avoids default through an agreement.

Aug 6, 2011: Standard & Poor’s downgrades US rating from AAA to AA+.

Reasons for US Debt Crisis

The various factors which led to this crisis can be summarized as:

  • Widening Gap between Income and expenses: Expenses due to various wars imposed post 9/11 and the 2008 recession pushed US spending to the brim and a grand canyon gap was created between income and expenses in 2008-2010.
  • Unemployment in US: Unemployment in US is at an all-time of 24% and US Government had to provide unemployment and medical benefits to them.
  • Accumulation of Debt: US debt and its interest has risen to equal the value of its GDP.

Possible Solutions and Drawbacks

Making More Money will lead to devaluation of dollar or in simpler terms lesser value of money leading to inflation. Increased taxeswill lead to possible job losses and rise ofunemployment and greater expense on unemployment and medical Benefits. Cutting expenses will slow down the recovery and interest on US debt could accumulate, leading to possible default.  Thus US isin a Catch-22 situation which may lead to double-dip recession incurred due to rise in inflation and slower Growth.

The Agreement… that saved the day

The US government avoided the default by making a deal  with the opposing Republican members in the House of Representatives as it was granted to raise the debt ceiling by $900 billion provided they cut back on expenses of $1 trillion in next decade.

What does it mean to rest of the world?

Though the future is not clear, USis the most powerful nation of the moment. A crisis there will effect the investments and thus development in other parts of the world as seen during the 2008 recession. If war expenses aren’t reduced, we must be ready for another storm. With rising inflation, corruption charges, inadequate power supply, Naxal trouble and cross-border terrorism, India has enough issues to battle with. A recession-like situation in US would only take attention away from these key points. But then, US is still a favored destination for investors and if history can be trusted then US has thwarted bigger crisis before. Most importantly, its high time for them to get the house in order before training guns on Osama’s successors.

Awshesh Shrivastava

Masters of Business Administration (2011-2013)

IIT Kanpur

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