US DEBT CEILING CRISIS - Prakriti Gupta

OVERVIEW
The United States debt-ceiling crisis was a financial crisis in 2011 that started as a debate in the United States Congress about increasing the debt ceiling. Since 1917, the US Congress has stipulated that there has to be a statutory limit on the US public debt (debt of US federal government). This limit has been periodically increased and stood at $14.3 trillion (95% of the GDP) as on 31st July 2011. According to Treasury, the US government would run out of cash to pay all its bills on August 2, 2011, which became the deadline to increase the debt ceiling.

IMPLICATIONS OF NOT RAISING THE DEBT CEILING The govt wouldnt have been able to pay employees, social security benefits, defence contractors, medical insurance bills and interest to lenders. Failure to raise the debt ceiling would have forced the government to reduce its spending by as much as ten percent of GDP overnight, leading to a corresponding fall in aggregate demand. Keynesian economists believed that such a significant shock, if sustained, would have reversed the economic recovery and sent the country into a double dip recession. Global impact: Govts, investors and businesses across the world will stop investing in the US bonds. There will be panic in the financial markets globally, with investors exiting equities for safe havens like liquid cash and gold.

WHOSE MONEY HAS THE US TAKEN?? Foreign countries (including china $1.2tn)

When did this debt accumulate??

$4tn
US public and companies

$3.6tn
US federal system

Barack Obama (fighting recession, wars in Afghanistan and Iraq) George W Bush (wars and tax cuts) Bill Clinton George Bush Ronald Reagan Earlier

$2.4tn $6.1tn $1.4tn $1.5tn $1.9tn $1tn

$6.2tn

AGREEMENT TO RAISE THE DEBT CEILING Democrats and Republicans agreed to raise the US debt ceiling, which has reached its cap at $14.3 trillion, to $16.4 trillion an increase of $2.1 trillion. The agreement also includes cutting the federal budget deficit by $2.5 trillion over the next decade. On the other hand, the plan doesnt include raising taxes.

US CREDIT RATING DOWNGRADED

In an unprecedented move, credit rating agency Standard & Poor's downgraded the US government's 'AAA' sovereign credit rating to AA+ - a development which raises concerns that investors will lose confidence in its economy. What does the downgrade mean? Investors like pension funds that have to mandatorily invest in AAA bonds may shift. What does this mean for India? In the short-term, the impact may be negative. Global investors react to any negative event by moving out of risky assets into safe assets such as Swiss currency or gold. There may be pressure on the rupee Where will investors go? With US debt accounting for 54% of AAA investments, there is no alternative market for investors that is deep enough. But for those keen on AAA investments, there are bonds from Germany, France, UK and Canada and also some blue chip companies.

HEADING TOWARDS ANOTHER RECESSION???....

Is the global economy facing a recession? Though a definite answer to that question is obviously difficult to provide, there is a growing consensus that the chances of a recession have increased in recent months. The main reason for this pessimistic outlook is the state of the US economy and the debt crisis in Europe, which is not just continuing but threatening to engulf countries that have escaped it so far like Italy and Spain. Besides, Japan, the worlds third largest economy, has been badly hit by the tsunamis after-effects, aggravating its pre-existing economic woes.

In the US, although the government passed a new act that increased the amount of money the country could borrow (called debt ceiling), poor economic growth numbers have raised the prospects of another recession in the worlds largest economy. As a result, there is a panic among global investors and they are rushing to get out of risky assets like stocks. However, according to many economists, the world is unlikely to plunge into a double-dip recession, notwithstanding the crash in global stock markets and the US loss of AAA rating from Standard & Poor's. The global economy is slowing down, and slow global growth may persist for years - this typically happens when a recession arises from a financial crisis. Some analysts are arguing that the threat of a double-dip recession is an unrealistic prediction despite the downward adjustment on the projected U.S. GDP and its recent credit rating downgrade. Employment has seen positive improvement for the last 10 consecutive months and large corporations are not teetering on the brink of collapse, which makes for a different landscape than what was seen in 2008. If a recession does occur, some observers are prepared to blame a pull back in spending based on low confidence and little else.

GOLD/SILVER PRICES SOAR DATE 1st Aug 5th Aug 9th Aug 11th Aug 13th Aug 18th Aug 21st Aug 24th Aug GOLD PRICE/10GM 23455 24335 25125 25845 26365 26685 28155 28195 DATE 1st Aug 3rd Aug 5th Aug 7th Aug 9th Aug 11th Aug 13th Aug 18th Aug 21st Aug 24th Aug SILVER PRICE/KG 58715 59120 60615 59400 60535 59085 60110 61090 63800 65285

Fears for an escalation of the debt crisis is the price of gold rising to record levels. Gold offers this quite a good security in times of crisis. The spurt in demand for gold is mainly due to US credit rating downgrade and a faltering economy, which boosted the demand for protection of wealth.

The yellow metal, gold astonished the whole economy by climbing to a life time high of Rs 28,155 per 10 grams and USD 1,800/ounce on 21st Aug. The surge in gold prices is basically due to the tension prevailing in our world economy- rising inflation, slow down of US market, European debt crisis, turmoil of equity market, depreciation of Indian rupee against US dollar etc.

SENSEX FLUCTUATIONS
Date 1-Aug-11 2-Aug-11 3-Aug-11 4-Aug-11 5-Aug-11 8-Aug-11 9-Aug-11 10-Aug-11 11-Aug-11 12-Aug-11 Low 18219.25 18037.87 17859.5 17664.73 16990.91 16759.45 16432 17022.25 17012.95 16784.56 Close 18314.33 18109.89 17940.55 17693.18 17305.87 16990.18 16857.91 17130.51 17059.4 16839.63 Date 16-Aug-11 17-Aug-11 18-Aug-11 19-Aug-11 22-Aug-11 23-Aug-11 24-Aug-11 Low 16673.52 16708.98 16433.31 15987.77 16046.48 16213.18 16253.78 Close 16730.94 16840.8 16469.79 16141.67 16341.7 16498.47 16284.98

Besides the ongoing European debt crisis, worries about raising the US debt ceiling by August 2 heightened the volatility in capital markets in July. Even though the debt ceiling was eventually raised, Standard & Poors (S&P) downgraded the US long-term sovereign debt on August 5 from AAA to AA+ for the first time ever. This led to a five to seven per cent decline in the US stock exchanges in one day on August 8, triggering a sharp reaction in global markets. Since then markets all over the world have been sinking downwards in a concerted manner. The Indian stock market has also been under tremendous pressure and its market valuations have dropped by $200 billion, with a 13 per cent decline in the Sensex. The Sensex fell below the 16k level for the first time in nearly 15 months on 19th Aug before recovering a little to close at 16,141.67, down 328.12 points, on frantic selling amid global equities sell-off on fears of a worldwide economic slowdown. The Korean index, KOSPI, like other Asian indices, hit the 2008 levels with a 6.2 per cent loss on August 19.

OVERALL IMPACT ON THE INDIAN ECONOMY

Indian economy may sustain the crisis as Indian economy is less dependent on exports. The software industry may get affected as out sourcing from west may decrease. This may slow down Indian software export orders. The advantage for India is with global recession the commodity prices decrease and this lead to lesser prices for goods and this reduces inflation as Inflation is the major drawback for Indian economy as on today in 2011. US outstanding debt stands at US$ 15 trillion. Foreign countries own nearly US$ 4.5 trillion of this amount. Currently, Indias exposure to US debt stands at US$ 41 billion and is ranked at 14th position in terms of country having exposure to US debt. China ranks first, having an exposure to the tune of US$ 1.15 trillion exposure.

SOURCES
http://livesharemarkets.com/2011/08/24/gold-at-rs-28000-how-long-will-the-rallycontinue/ http://www.ourinvesting.com/2011/08/double-dip-recession-2011-in-usa-impact.html http://in.reuters.com/article/2011/08/10/idINIndia-58720020110810 http://www.ourinvesting.com/2011/08/double-dip-recession-2011-in-usa-impact.html http://www.indiagoldrate.com/get-gold-history.htm http://indiatoday.intoday.in/site/story/s&p-downgrades-us-credit-rating-fromaaa/1/147226.html http://www.business-standard.com/india/news/nagesh-kumar-global-economiccrisisasia-pacific/446880/ http://www.nuwireinvestor.com/articles/only-fear-to-blame-if-double-dip-recessiondevelops-57684.aspx THE TIMES OF INDIA NEWSPAPER