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Month: January 2013

Dancing On The Debt Ceiling

Last week we outlined the resolution to the fiscal cliff and pointed to a bigger crisis that may await the US in just a few weeks. This new crisis will result from a failure of US lawmakers to raise the nation’s debt ceiling.

To recap, the debt ceiling is a mechanism that allows the government to increase its borrowing capacity in order to honour previous obligations. In today’s editorial we will describe why there is a debt ceiling and why it poses such a serious risk to the US economy.

Why the ceiling?

Typically when the US government proposes a federal budget it looks at the amount of tax revenue coming in versus the amount of spending required.  If tax revenue exceeds spending, the government operates a budget surplus.

When spending exceeds tax revenue, the government makes up the shortfall by borrowing money.  However approving spending and raising the additional debt are two separate things under US law.

Congress may approve a budget (or a law that requires spending), but the deficit is only financed when the debt ceiling is raised. Throughout the history of the US, the debt ceiling has routinely been raised in order to continue spending that has already been approved by Congress.

However approving a budget with deficit spending and borrowing the actual money to finance the spending are two completely separate things from a legislative perspective. Congress passes a law approving spending and then must pass another law authorising the borrowing needed to finance the spending.

21st century

The debt ceiling has taken on added significance throughout the 21st century because of the sheer scale of debt the government has racked up. The last time the government ran a surplus was back in 2001.  From a surplus of US$127.3 billion in 2001, the US has racked up 12 consecutive years of deficits.

Following the GFC in late 2008, the government posted a record US$1.4 trillion deficit in 2009 as it undertook emergency stimulus measures to rescue the economy.

In each of 2010, 2011 and 2012, the budget deficit topped US$1 trillion as tax revenue shrank due to high unemployment and a tepid economic recovery. The continuous run of deficits has resulted in an exponential increase in gross federal debt over the past 12 years, as the chart below shows:

debt ceiling

What happens if the ceiling is hit?

We know that for every year of deficits, the government must increase the debt ceiling in order to finance spending obligations. Now we address what happens if the debt ceiling isn’t raised. Specifically, what if the government has already committed to a spending program but finds that it is unable to borrow the money because lawmakers refuse to raise the debt ceiling?

Remember that tax receipts and borrowings together are used to finance government spending. Because there is no new borrowing, tax receipts alone will be insufficient to meet all spending requirements.

The US government would not be able to fund things like welfare payments (including jobless benefits), and it would almost certainly be forced to default on some of its obligations, including those to its creditors.

Many economists expect a US default will spark a new financial crisis. The convulsions in bond markets would create upward pressure on US interest rates, worsening the deficit as well raising borrowing costs for businesses and consumers alike.

It would also mean that the limited amount of government revenue would have to be diverted from essential programs to pay for escalating interest costs.

Ultimately, the US economy would crash under the weight of a deep recession and a government default. Understandably, a US default would have serious implications for the world economy.  Even the threat of default would be enough to send markets into a tailspin.

In next week’s editorial, we will conclude our discussion on the debt ceiling by assessing the likely market reaction to the debt ceiling standoff and look at why the debt ceiling has become such a hot button topic among US politicians.

Dancing On The Debt Ceiling is a post from: Australian Stock Report Market Pulse Blog

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Morning Market Update: Mixed Results Overnight

International equity markets traded with mixed results on Friday night amid positive data from China and concerns about the US debt ceiling. Statistical data showed that China’s GDP climbed 7.9% in the fourth quarter last year, higher than the prior quarter’s 7.4%.

In the US, the Treasury Department has announced that the nation will go over its $16.4 trillion borrowing authority come mid-February to March.

House Speaker John Boehner commented that the Republicans plan to vote for a three-month extension of the borrowing authority in order to steer the Senate to come up with a budget.

In Europe, the UK’s FTSE added 22 points (+0.4%) to settle at 6154 whilst Germany’s DAX fell 33 points (-0.4%) to settle at 7702. France’s CAC declined three points (-0.1%) to settle at 6154.

In the US, the Dow Jones climbed 54 points (+0.4%) to settle at 13650 whilst the S&P increased five points (+0.3%) to settle at 1486. The Nasdaq traded flat to settle at 3135.

In the commodity space, oil traded higher on the back of China’s positive GDP results and after the International Energy Agency lifted its forecasts.

Crude oil for February delivery added $0.07 to settle at $95.56 per barrel. Gold for February delivery declined $3.80 to settle at $1,687 per ounce as demand for the US dollar increased.

In the currency space, the Japanese yen traded lower due to concerns that the BoJ might implement further monetary easing to spur economic growth.

The euro fell against most of its counterparts after ECB board member, Mr. Benoit Coeure, mentioned that bank repayments of long-term loans are unlikely to impact the region’s overnight interbank rates. The US dollar finished higher against its peers as markets did not react as strongly as expected on China’s GDP data.

There is no major local economic data slated for release today.

Morning Market Update: Mixed Results Overnight is a post from: Australian Stock Report Market Pulse Blog

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Morning Market Update: Quiet Overnight

International equity markets finished with mixed results overnight as the upcoming US financial-reporting season raised concerns on earnings.

In Europe the UK’s FTSE fell by 14 points (-0.2%) to settle at 6108, whilst Germany’s DAX added 14 points (+0.2%) to settle at 7730. France’s CAC rose two points (+0.1%) to settle at 3708.

In the US, the S&P declined one point (-0.1%) to settle at 1471 whilst the Nasdaq fell eight points (-0.3%) to settle at 3118 after Apple’s share price fell by 3.8% after reports surfaced that the firm decreased iPhone production due to a lack of demand. The Dow Jones increased by 19 points (+0.1%) to settle at 13507.

In the commodity space, crude oil for February delivery added $0.58 (+0.6%) to settle at $94.14 per barrel after an increase in heating oil demand due to forecasts of cold weather in the US.

Gold futures for February delivery added 0.5% to settle at $1669.40 per ounce as investors sought safer alternatives amid concerns that the US government might implement more easing policies.

In the currency space, the Japanese yen fell against the US dollar yet again on escalating concerns that Prime Minister, Mr. Shinzo Abe, will choose a BoJ governor who favours more aggressive monetary policies.

The euro finished with slight gains against the greenback amid optimism that the eurozone will make a recovery in the near future. There is no major local economic data slated for release today.

Morning Market Update: Quiet Overnight is a post from: Australian Stock Report Market Pulse Blog

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Morning Market Update: We Are Back For 2013

International equity markets mostly finished with modest gains on Friday night after it was reported that China’s exports increased 14.1% in December, higher than the expected 5%.

In Europe, UK’s FTSE added 20 points (+0.3%) to settle at 6123 whilst Germany’s DAX gained seven points (+0.1%) to settle at 7716. France’s CAC increased three points (+0.1%) to settle at 3706.

In the US, the Dow Jones rose 17 points (+0.1%) to settle at 13488 whilst the S&P traded flat to settle at 1472. The Nasdaq added four points (+0.1%) to settle at 3126.

In the commodity space, both oil and gold fell after statistics showed that China’s consumer price index increased 2.5% in December spurring speculation that the Chinese government might not implement further policies.

Crude oil for February delivery dropped $0.26 to settle at $93.56 per barrel whilst gold futures for February delivery fell 1% to settle at $1660.60 an ounce.

In the currency space, the Japanese yen fell to a 30-month low against the US dollar after it was confirmed that Japan intends to spend 10.3 trillion yen ($116 billion) to stimulate the economy. The euro climbed against most of its peers after ECB President, Mario Draghi, mentioned that he foresees economic recovery in the euro area.

Today will see the release of the MI inflation gauge (10:30am, AEDT), the ANZ job advertisements (11:30am, AEDT), and home loans data (11:30am, AEDT).

Morning Market Update: We Are Back For 2013 is a post from: Australian Stock Report Market Pulse Blog

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