As US president Barack Obama and Republican leaders try to avert a federal debt default, both sides are threatening dramatic consequences, including a global recession. But some analysts say everything will be all right. What are the risks and how vulnerable is the Netherlands?

The US government has until 2 August to reach an agreement. By then, the government coffers are likely to be empty. To avoid this, President Obama, his Democratic party and the Republicans have to agree to raise the debt ceiling and, eventually, taxes. This basically means that Washington will borrow more money and companies and people will pay more taxes.

At the moment, Democrats and Republicans are at odds over how to fight the country’s financial woes, which remedies are needed to do that and to what extent each of those remedies should be applied.

What happens if they fail to reach an agreement? Dutch Economist Matthijs Bouman predicts a doomsday scenario. If a solution remains out of reach and the coffers remain empty, a worldwide recession will be inevitable.

Bouman:  “Washington would no longer be able to pay federal employees salaries, social welfare, Medicare, Medicaid or bills for goods and services purchased. Nor would it be able to pay the interest on loans from foreign investors. This would trigger a domino effect. Banks and investors holding US government bonds would suddenly find their investments worth far less than originally predicted and the dollar exchange rate would plummet”.

The scenario is fairly simple: investors across the globe would lose faith in US government bonds, the value of the dollar would drop dramatically and interest rates would rise equally dramatically. Washington would have to pay more in order to continue to borrow. Loans would be more expensive for everyone, consumers would curtail spending, companies would shelve expansion plans and investments and economic growth would stagnate or even shrink.

Dutch investors, including pension funds and insurance companies, would be hard-hit too, since they all have millions of dollars worth of US government bonds in their portfolios. After all, until very recently US bonds were considered a safe investment option.

Worldwide recession
If the value of the dollar plummets, the value of the euro will rise and exports to the US will cost more. That is not a huge problem for the Netherlands. In 2009 just 4.5 percent of goods exported from the Netherlands went to the US. Additionally, oil, which is valued in US dollars, would be cheaper. But a global recession would drag the Dutch economy down. Right now, this scenario seems unlikely. According to Michel van der Stee of Van Lanschot Bankiers, the vast majority of analysts still have faith in the US economy.

Van der Stee: “At the moment, the US has AAA status, the highest credit rating a country can have. Even if Washington runs into financial difficulties and the credit rating is lowered by the rating agencies, I still believe America will remain the largest and most liquid market and the demand for US government bonds will not suddenly die out. I don’t think that anything will in fact change very much.”

Federal debt default
Almost no one believes that the US will renege on its debts; it’s a situation that can only endure for a very short period of time. If it were to occur, it would affect only those people whose government bonds had come due.

The US national debt -  which amounts to $45 million for every US citizen - remains a concern. Why is there such concern over the Greek national debt when that only amounts to $42,000 per person?

Van der Stee: “One big difference between the USA and Europe is that the US is one country with one government. It remains an economy that can print money if necessary, something the Fed has done fairly often. But the biggest difference is that the US is a very competitive economy while that of Greece is not.”

Van der Stee agrees with critics in China and Europe who accuse the three large (US) credit rating agencies of applying a double standard—in favour of Washington. That, perhaps, is another reason why US politicians are too lazy to reach a quick agreement and stabilise the markets.

(jc/cl)

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