World economies fear being collateral damage of US government shutdown

The stalemate in Washington has governments around the globe fearing a potential financial disaster if the United States defaults on its debt

PUBLISHED : Wednesday, 09 October, 2013, 12:00am
UPDATED : Wednesday, 09 October, 2013, 5:40am

The bitter fiscal stalemate in Washington is producing nervous ripples from London to Bali, with increasing anxiety that the United States might actually default on a portion of its government debt, setting off global financial troubles and undercutting fragile economic recoveries in many countries.

Five years after the financial crisis in the United States helped spread a deep global recession, policymakers around the world again fear collateral damage, this time with their nations becoming victims not of Wall Street's excesses but of a political system in Washington that to many foreign eyes no longer seems to be able to function efficiently.

There is plenty of evidence that the US remains engaged globally on many levels, with the dual commando raids on targets in Africa this weekend the most recent. But the partial shutdown of the US government has shown again that Washington's problems extend beyond American borders. Effectively grounded by the political crisis at home, US President Barack Obama was absent from a summit meeting of Pacific Rim leaders in Indonesia on Monday, giving China greater opportunity to highlight its role in the region.

One of those at the summit, President Vladimir Putin of Russia, provided a possibly sardonic statement of sympathy for Obama. "We see what is happening in US domestic politics and this is not an easy situation," Putin said, adding: "If I was in his situation, I would not come, either."

China and Japan, the United States' biggest creditors, are increasingly worried the US government shutdown and stand-off over the debt ceiling could wreak havoc on their trillions of dollars of investments in US Treasury bonds.

Beijing and Tokyo have publicly called on the White House and Congress to resolve the dispute, which could threaten a US debt default as soon as next week, and Asia's two biggest economies are privately urging Washington to find a solution.

China's Deputy Finance Minister Zhu Guangyao said on Monday that Beijing had been in touch with Washington over the stand-off, in which House Republicans have refused to increase the debt ceiling as they seek changes in Obama's signature health care law.

Japanese officials held several emergency telephone conferences with US Treasury Department officials on Monday. Tokyo urged the Americans to hammer out a deal to increase the debt ceiling or risk a default that could plunge financial markets into turmoil.

The world's biggest debtor and creditors are caught in a delicate balance that neither wants to disturb. As at July 31, China held US$1.28 trillion in US Treasury bonds and Japan held US$1.14 trillion, according to Treasury Department data.

The last big confrontation over the debt ceiling, in August 2011, ended with an 11th-hour agreement under pressure from shaken markets and warnings of an economic catastrophe if a default were allowed to happen.

China was "naturally concerned about developments in the US fiscal cliff," Zhu told reporters, saying it was Washington's "responsibility" to avoid a debt crisis and ensure the safety of Chinese investments.

Japan has previously expressed its concerns in diplomatic terms. Finance Minister Taro Aso and Chief Cabinet Secretary Yoshihide Suga both said last week that the fiscal stand-off was essentially a US domestic problem.

But Aso added the shutdown could push up the yen against the dollar - a concern for Japan's export-reliant economy, which has benefited from a yen decline since Prime Minister Shinzo Abe won election in December on a reflationist policy platform.

Should the US default on its debt, which the Treasury Department says could happen as soon as October 17, "there would be a large international impact," Aso said last week. "If there is no prompt resolution, various impacts will emerge."

In Europe, the effort to reach a big new trade accord with the United States is at a standstill, with many government agencies in Washington operating with skeletal staffs.

And as worrisome as that kind of delay is in Europe, it is only a precursor to the almost certain economic fallout if the United States does not raise the debt limit and defaults for the first time on government securities.

Foreigners often complain, usually with some forbearance, that the United States is so powerful that its president is in some important sense their president, too. In their case, however, they lack the opportunity to cast a vote.

There is not much that any foreigner can do about Obama's confrontation with House Speaker John Boehner, who said on Sunday that his Republican members would not accept a clean bill - one with no conditions - that would raise the American debt limit before the government hits its borrowing limit and risks technical default. At the same time Boehner has told colleagues privately that he would avert a default, but whether he actually has the ability to do so remains uncertain.

"The international community is asking, 'Does the US still have the will to act?'" said Xenia Dormandy, a senior fellow at London's Chatham House and a former American official in the State Department and the National Security Council under president George W. Bush.

"Both the Syria vote and the current budget crisis are nerve-racking for the world," she said, referring to Obama's sudden decision to ask Congress to authorise a strike on Syria and then changing his mind.

Alain Frachon, a columnist and former Washington correspondent for the French newspaper Le Monde, said: "Washington is looking more like the Italian political system, with its permanent crises, and not a presidential system, as before.

"People are worried about the debt ceiling - it could be the little drop that could trigger another crisis in financial markets," he said.

"And it's just when there was the perception for the first time in the long sovereign debt crisis that there is a window of opportunity to breathe a little bit and to introduce a bit more suppleness into the way we've managed it."

The anxiety was all over Europe, Frachon said, and it came just as Greece and Spain seemed to be turning around, as there were spurts of growth that promise an end to recession, and as Germany had gotten through its elections and Italy through another political crisis.

Another financial meltdown would hurt France, too, he said, and not just Greece, Portugal and Spain. "People don't want to see all this fragile equilibrium destabilised by a possible financial crisis provoked in Washington," he said.

Jean-Paul Fitoussi, an economist at the Institut d'Itudes Politiques de Paris, said a default would slow the US economy and depreciate the dollar, "so it would lead to a loss of competitiveness in Europe at the very moment when all policies in Europe are aimed at increasing competitiveness, and that would be very bad news".

Perhaps worse, he said, was that "the banking system in Europe remains fragile, so more bad news could have unforeseen consequences on the world's financial system".

The United States had gone through government shutdowns before, Fitoussi noted, but this time it felt different, even if it turned out to be short-lived.

"Perhaps we have not completely understood the American Constitution and the effective power of the president is not as strong as we believed," he said. "And maybe it's because Obama is not using his constitutional power very well."

Additional reporting by Reuters