US debt standoff threatens to turn crisis into catastrophe

I go away for a few days and the pace of change accelerates!  In approximately 13 days the US are going to have to decide whether they can make their next credit card payment or default on their debt.  The world waits...

• Republicans insist on spending cuts without raising taxes 

• Obama sets 22 July deadline for action

• JP Morgan chief warns of severe damage to global economy if US defaults

guardian.co.uk, Thursday 14 July 2011

The US faces the prospect of a "catastrophe" as President Barack Obama stands firm against Republican demands for deep spending cuts without any tax increases as the condition for raising the country's borrowing limit and avoiding a debt default.

With Washington gripped by a growing sense that it may be too late to avert a crisis, the president has said he will give the increasingly rancorous negotiations until the end of next week to reach agreement on the terms for raising the US's $14.3 trillion (£8.9tn) debt ceiling.

The White House has said that if there is no agreement by 22 July, then discussion about budget cuts and taxes should be abandoned in favour of legislation dealing solely with raising the debt ceiling before the borrowing limit is reached on 2 August. But the Republicans have rejected legislation without agreement on budget cuts.

With European leaders also facing a potentially ruinous debt crisis, a leading Wall Street figure described the prospect of a US default as catastrophic.

Jamie Dimon, chief executive of JP Morgan, one of Wall Street's biggest banks, said: "No one can tell me with certainty that a US default wouldn't cause catastrophe and wouldn't severely damage the US or global economy. And it would be irresponsible to take that chance."

On Wednesday, Ben Bernanke, the chairman of the Federal Reserve, warned of a "huge financial calamity" if a political agreement is not reached. He told Congress a default would "send shockwaves through the entire financial system".

Hours later, the credit ratings agency Moody's warned that it may downgrade the US's AAA credit rating, saying there is a "rising possibility" that no deal will be reached by next month's deadline.

On Thursday, Moody's threatened to downgrade the AAA ratings of government lenders Fannie Mae, Freddie Mac, Federal Home Loan Banks and Federal Farm Credit Banks, illustrating the vulnerability of the already depressed housing market to a government default.

Talks continued on Thursday but failed to make progress. Obama told congressional leaders that unless a framework deal is agreed on Friday then negotiations will continue through the weekend.

China, the US's biggest creditor, added to the pressure on Thursday by publicly urging Washington to protect investors' interests. The dollar continued its fall as investors shifted to other assets such as gold, which hit a record high on Thursday.

At the heart of the political wrangling is a determination by each side to blame the other for a stagnant economy, with unemployment remaining stubbornly high at above 9%. The latest economic figures showed only a 0.1% increase in retail sales and a minor drop in the number of new jobless claims – by 22,000 to 405,000 last week – suggesting the rate at which companies are laying off workers is falling.

If the debt ceiling is not raised by 2 August, Obama will be forced to decide which parts of the government to shut down and which to keep going using continuing tax revenues, as well as how much of those revenues to direct to meeting payments to foreign holders of US bonds.

The president would have to decide whether to cut off unemployment benefits for those out of work and pension payments to the elderly. He might freeze the military payroll, a large expense but a move bound to bring stinging attacks from the Republicans. Many, if not all, government offices would close.

"You would have to make heinous choices about which bills you would pay," said the White House press secretary, Jay Carney.

The Republicans propose $2.4tn in immediate spending cuts with no tax increases. Obama says the scale of those cuts demanded by Republicans can be reached, but only in several stages, and that tax increases are essential to reduce the deficit.

But the Republicans won control of the House of Representatives in November's election on a platform of promising no new taxes. Newly elected members fear compromise will cost them voter support.

Concern that agreement will not be reached has been reinforced by Republican claims that Obama stormed out of a meeting on Wednesday evening.

Eric Cantor, the House majority leader, said the president "got very agitated, seemingly" and quoted him as saying: "Eric, don't call my bluff. I'm going to the American people with this." Democrats disputed the account.

Prospects for a deal are further undermined by divisions within the Republican party. House Republican leaders believe much of the country will blame Obama for any economic consequences of a default on the debt. But the party's Senate leadership is more sceptical.

The Republican leader in the Senate, Mitch McConnell, fears his party will share the blame if the US defaults on its debt and the economy suffers. "I refuse to help Barack Obama get re-elected by marching Republicans into a position where we have co-ownership of a bad economy," he told a radio show.

McConnell noted that a shutdown of the government in 1995 helped re-elect Bill Clinton as president the following year after voters blamed Republican leaders in Congress. He has attempted to buy the Republicans a way out by proposing Congress hand over power to raise the debt ceiling to Obama without first approving spending cuts. That would shift responsibility for increased spending to the president and allow the Republicans to say they worked to keep to their commitment.

But McConnell's proposal was rejected by his own leadership in the House of Representatives, which fears anything short of substantial spending cuts will be viewed as betrayal by Republican voters.