View from my glasses: The Ghost of Recession that looms over: US Debt Crisis

US on Tuesday 2^nd August increased the limit of Sovereign Debt Limit. US has a Sovereign Debt Limit of 14.294 trillion$. To present before you some facts, figures and interpretations, it becomes pertinent that we throw some light on certain facts that lay foundation of this situation.

In 1917, US began borrowing to finance its entry into World War I. The borrowing spree gathered momentum from the era of Reagan borrowing from Treasury more than 1 trillion $. During the eight years of Bush’s regime, the total borrowing crossed more than 6 trillion $. It was hugely because of the wars waged on Afghanistan and Iraq. US presently has spent more than 3.5 trillion $ on the restructuring to be done of Wars in Iraq and Afghanistan.

What does it mean if US defaults on Sovereign Debt limit. It would imply when the private institutions are about to default there would not be anyone else other than US government to help them but in case of Sovereign Debt Default even US government will not be able to provide loan or bailout packages to private organisations. The government will have to rely on other sources of revenue like tax collection. The Bureau of Economic Analysis tells that total US spending has increased from 27% of GDP in 1960 to 37% of GDP today. The Tax Foundation shows that between 1986 and 2009 the average number of zero tax payers or negative tax payers increased from 18.5% to 51%.There can be closing of certain public offices. Mean while, the US gross debt as percentage of GDP increased from 42 % of GDP in 1980 to 100 % of GDP in 2011. Thus, the prevailing conditions aided by this scenario would bring the whole economy into global melt down.

Thanks to America’s decision of increasing the upper cap of Sovereign Debt Limit, there has been a boost in investors’ confidence. But this also indicates fears of global meltdown. Hence investors are taking out their money from market and investing in safer havens like gold, silver and other precious metals like Platinum and Palladium. The global meltdown is further fuelled with European Debt crisis. Hence, investors vary of their wealth and trying to switch to safer havens which include US government security bonds. US will continue to remain safer haven because of innovation and academic strength in economy. On an average daily average trading in US bonds is approximately 518 billion$ in contrast to British gilts of 34 billion $ and German bunds of 28 billion $. All these figures show the investor confidence in US government security bonds in spite of the fact that not a long ago the US, the UK and Germany enjoyed credit rating of AAA.

On 5^th August, S&P downgraded its rating of AAA to AA+. In 1917, Standard and Poors gave US AAA rating. Since then it has enjoyed a patriarchal status and investor confidence. It has been able to maintain this status because of its academic strength and innovation. A rating of AA+ increases the element of risk relatively in an investment. To retain the continuing investment, US Government is supposed to increase the interest rates. Since an investment at greater risk ought to give better returns. This would imply higher costs of taking a loan. This will curb the liquidity in the market.

China holds approximately 25.7% of US Treasury securities at 1.159 trillion $ till May 2011. China’s state controlled credit rating agency Dagong Global Credit Rating Co. has already reduced the credit rating of US implying severe cuts in China’s investment in US bonds. Moody and Fitch still maintain the AAA rating for US Warren Buffet’s majority share holder in Moody ( S&P’s rival ) maintains that this debt crises will not affect the US as investment shore denying any fears of double dip recession.

What this holds for India, India has 0.9% of US Treasury securities which is negligible when compared with economies of scale. Goldman Sachs expects India to grow at the rate of 7.3% from previous rating of 7.5%. RBI expects the country to grow at 8%. Emerging markets are still a safe bet for FIIs but the sentiment will find place in heart of investors with time. The present decline is because of removal of foreign money from Hedge Fund Managers/Investors and private investors vary of their funds. Sensex was the worst performer vis a vis global indices. Meanwhile, Goldman Sachs has upgraded India rating to Market weight from the previous underweight rating for past one year. The future cannot be predicted but with Indian Foreign investment policies and growth rate we can be assured that recession shocks will come to India after passing through these buffers.

World Countries by S&P’s Credit Rating Legend just before US Debt Crisis