In the eye of the storm

Could we say that the US debt crisis is over after an agreement was reached last month between US President Barack Obama and the Republican Party?

Will the repercussions of the debt crisis and this fragile agreement continue to deepen the crisis of the US economy and that of the global economy as well?

The agreement, which was approved by the Congress last month after painful negotiations, provides for increasing the debt ceiling by $2.1 trillion, thus allowing the US Treasury to fulfill its payment obligations until 2013 and reduce expenditure by $2.4 trillion in two phases spanning 10 years.

It seems that this agreement is just a temporary solution to the US addiction to borrowing that cannot be covered by the allocated amount if the rate of borrowing, which is estimated at an annual average of $1.5 trillion, remains as it is.

During Obama's administration [only two and a half years], the debt increased by 43 per cent, as the debt reached $14.3 trillion in August, compared to $10 trillion in 2008. Also, the deficit reduction — by an annual average of $240 billion over ten years — seems doubtful under deteriorating financial conditions in the US.

This is logic that the US debt is expected to rise to $15.5 trillion by the end of this year and $16.7 trillion by the end of 2012, which exceeds the new ceiling of nearly $16.4 trillion.

What makes things worse and increases doubts is that this financial matter has been exploited to become an issue of election, as this issue will be excessively exploited in order to support the candidate of one of both parties in the presidential election next year.

After the debt deal, some Republicans said that spending would not be regulated without removing Obama from the presidency next year, especially because the election will coincide with the end of the time period for the new debt ceiling and deficit reduction. Then Obama will find himself sinking up to his ears in a sea of public debt, budget deficit and unemployment resulting from spending cut.

Although the agreement gave President Obama the chance to take a breath and seize this available opportunity, the weak response from global financial markets leads to elevating the state of uncertainty towards this agreement and its potential contribution to saving the US economy and the world economy from a new financial crisis that could be worse than the previous one.

At the same time, this agreement did not help in avoiding the downgrade of the US sovereign credit rating which may well have grave consequences on the global economy and foreign investments, including the Arab ones. Although the move, because of the current global economic climate, did not have immediate serious impacts on US treasury bonds it may imply negative consequences in the longer term.

Since US Treasury bonds were to be considered one of the safest forms of investment with a fixed return in the past three decades, rich countries and central banks around the world have invested hundreds of billions of dollars in them.

Also, emerging countries such as China, Brazil, Russia and oil-exporting countries have joined the advanced industrial countries, such as Britain, Germany, France and Japan, in investing in US Treasury bonds. Some emerging countries have even surpassed industrial countries to which the US is indebted. Lowering the US sovereign rating and the possible inability of the US to pay back these loans is a very serious issue, because it will affect all the efficient economies in the world.

Commenting on the issue, Christine Lagarde, the managing director of the International Monetary Fund, described the situation as "very dangerous".

Meanwhile, the official People's Daily newspaper, the mouthpiece of the Chinese Communist Party, called the US handling of its debt crisis "irresponsible" and "immoral" and accused US politicians of "sacrificing other people's interests in exchange for a few votes".

Even Russian prime minister Vladimir Putin has launched a scathing attack on the US, accusing Washington of living like a "parasite" on the world economy and living on debts, not on its economic capacity.

With regard to Arab investments, they are estimated at $400 billion in Treasury bonds alone, which is expected to fall by at least 10 per cent in the case of downgrading the US sovereign credit rating.

In addition to Arab direct investments, heavy losses are expected as a result of the possibility of reducing the sovereign credit rating as several Arabian currencies are pegged to the US dollar, which is expected to suffer big losses in global exchange markets. Consequently, Arabian currencies are expected to suffer huge losses.

Despite this gloomy picture, there is room for the US to overcome its debt crisis. However, the opportunity is very small, because the US Treasury had earlier failed to pay its bills in 1979, when the debt did not exceed $830 billion. Back then, delay fines were paid to investors, which may not be available in the present crisis because of the huge debt size and the declining financial capacity of the US.

Therefore, monitoring financial developments in the US in the next couple of months will be of exceptional importance to minimise potential risks and losses for investors, while taking into account all the possibilities related to the development of the US economic conditions. 

Dr Mohammad Al Asoomi is a UAE economic expert and specialist in economic and social development in the UAE and the GCC countries.