For weeks, investors had seemed uncharacteristically calm in the face of the US inability to agree on a solution to the looming default. Traders who have become accustomed to running in panic from the euro at the slightest sign of debt concern in the European Union have shrugged off the Washington stalemate. "They'll make a deal," seems to have been the attitude.
That now seems to have changed. Stocks plunged on Wall Street on Wednesday, with the Dow Jones index dropping 200 points and interest rates on US bonds shooting up. Investors have also begun rushing to buy credit default swaps as an insurance policy against default.
Europe too is concerned. Just as the US urged the euro zone recently to accelerate its efforts to solve the Greek debt crisis, European leaders have now begun demanding action in Washington.
German Finance Minister Wolfgang Schäuble, widely respected in the US capital for his forthrightness, is the latest. "Everyone in the US should be aware of their responsibility for the global financial markets," Schäuble told the daily Passauer Neue Presse on Thursday. He added that he remained confident a solution would be found, but "even then, America's problems won't be solved. The core of those difficulties is exorbitant debt and the economic prospects. Americans have to find long-term solutions to create solid fiscal and growth policies."
Potentially Severe Consequences
The US doesn't have much time left to take such an important step of its own. The deadline for raising the debt ceiling -- which would allow US President Barack Obama to continue paying the nation's bills such as veterans' benefits and welfare payments -- is August 2. Should Republicans continue to block ongoing efforts at finding a compromise, the consequences could be severe.
"The danger that the US becomes insolvent in less than a week has massively fueled unease," Klaus Regling, head of the euro backstop fund known as the European Financial Stability Facility, told German tabloid Bild on Thursday. "Nobody knows what would happen if the largest economic power in the world would suddenly stop paying interest on its debt. That has never happened before. It would stir up the global economy."
Christine Lagarde, the new head of the International Monetary Fund, said on Tuesday that a US default would be a "very, very serious event, not just for the US, but for the global economy at large."
Indeed it would. US bonds have long been seen as the safest in the world. Even if Washington stopped interest payments for just a few days, it could have global consequences far greater than a Greek bankruptcy. Investors would be left not knowing who to trust -- particularly given debt problems in the euro zone and ongoing economic difficulties in Japan. Lack of confidence in global economic leaders would almost certainly lead to serious global economic difficulties.
'Get Your Ass in Line'
Even if the worst is avoided, US finances are still a mess. Total debt is approaching 100 percent of gross domestic product, putting it in the same league as Italy, Portugal and Ireland, three of the euro-zone's famous PIIGS states. America's budget deficit is well over a trillion dollars -- more than 10 percent of GDP. Were Washington to apply to become a member of the European common currency zone, it would be rejected out of hand.
Conservative Republicans in Washington have pointed to such economic indicators in explanation for their refusal to give an inch in the ongoing battle with Obama. Yet while Republicans have insisted on massive budget cuts, they have refused to consider raising taxes on America's richest. While Obama has been seeking to give a little in an effort to find a compromise, the Republicans, who many believe have been following the lead of the arch-conservative Tea Party movement, have done nothing but take.
Even some in Europe have begun to question the sanity of the debate in Washington. Vince Cable, Britain's secretary of state for business and a member of Prime Minister David Cameron's cabinet, said this week that a deal was being held up by "a few right-wing nutters in the American Congress."
There were some indications on Wednesday that the Republicans might finally be moving towards a deal. Republican Speaker of the House John Boehner, who has repeatedly been hobbled by the rank-and-file in his efforts to reach agreement with Obama, told lawmakers from his party to "get your ass in line."
Whether they will do so remains to be seen. Investors and European leaders are watching.
cgh -- with wire reports
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