May 30, 2023

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The dramatic effects of the US bankruptcy

We are now one week away from the moment the cash reserves of the American public are depleted, at least according to the most competent person, the Secretary of the Treasury. Janet Yellen. If by then no agreement has been reached between the two American political factions to increase it borrowing maximum For the US government (the debt ceiling), the consequences could be very important for the economy and international markets.

This limit is at the moment 31.4 trillion dollars, as it has increased by no less than eighty times since 1960 until now. We also know the two main representatives of the two factions, the Democratic President Biden and the Republican House Speaker. Kevin McCarthyRelevant negotiations began weeks ago, assuring the public that a solution to the issue will be found in a timely manner.

But the truth is that it is not very easy to come to an agreement, because it must be approved by both Parliament and the Senate. With the climate between the two extremes polarizing and the presence of many cadres, in both factions, who could easily push things to extremes, the possibility of an “accident” was not insignificant at all.

In fact, according to the team of economists at JPMorgan Chase, on Wednesday that probability was at 25% and it’s rising as the hours go by and negotiations drag on without result. A big thorn that the Republican side is demanding Cut costs hundreds of billions of dollars (perhaps trillions) from the federal budget in order to give her approval. This does not align with the Democratic side and makes Joe Biden’s negotiating position difficult.

So what if both sides can’t get legislation passed by the House and Senate before the day the US government runs out of money? We don’t have to look far to say that. We have before us the statements of Treasury Secretary Janet Yellen and the estimates of White House economists.

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Yellen has repeatedly stated that a possible default at the US Treasury would have “catastrophic effects” on the US and international economies and International stock and bond markets. He warned of a global economic slowdown that would hurt the economic recovery that followed the pandemic. Another catastrophic result will be a major disruption in the exchange rates of the dollar with other international currencies, which will lead to serious problems in international trade.

The estimates of the White House economists are somewhat more specific and include three scenarios: an early resolution of the issue after arduous negotiations, a temporary suspension of payments, and a prolonged halt to payments due to the impossibility of reaching a political agreement. . Even in the most positive scenario, which is avoiding default after negotiations, White House economists estimate that there will be negative consequences, such as losing at least 200 thousand jobs and the GDP decreased by 0.3%.. But what causes horror is their expectations about the consequences of prolonged default, that is, a three-month period during which the US government will not be able to pay a significant part of its obligations to its creditors and to US citizens.

In such a situation, economists estimate that up to 8 million jobs will be lost and stock market panic will ensue with The US stock market loses 50% of its value. The last assessment seems outrageous but we must remember 2011, when we went through a similar situation. Despite the fact that the deal was struck two days before the day the money was due to run out, the S&P 500 lost 19% of its value in the few weeks after the deal was reached.

The fact is that things were a little different at that time, Europe was experiencing debt crisis in different countries, while the downgrade of the US government debt rating by the rating agency Standard & Poor’s also played an important role. Of course, when talking about rating agencies, we must say that two of the most popular rating agencies, namely Fitch And DBRS Morningstar, took the small step of showing their concern about the lack of apparent consensus in the consultations between the two sides. Both agencies, Fitch on Wednesday and DBRS Morningstar on Thursday, have put US debt under review with expectations of a ratings downgrade. They both rate the US at the highest possible AAA rating and believe a deal will eventually be struck even at the very last minute, but it’s clear they decided to issue a small warning.

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Secretary Yellen’s warnings certainly have a political element and may contain elements of exaggeration. We don’t know if the same is true of the White House economists, but their predictions of the consequences of a prolonged partial default give us a good picture of what would happen to the markets if we defaulted even for one day.

We don’t know if the stock market will lose 50% of its value but it certainly won’t react positively at all, no matter how much it likes to play its new game. Wall Street, artificial intelligence. Of course, the problems will not be limited to the US stock markets, because we know that the international stock markets usually act as vessels of communication. It is also certain that in such a situation there would be great turbulence in the international exchange rates, as Yellen had already pointed out. As strange as it sounds, we don’t know if this will take the form of a sharp decline or a sharp rise in the value of the US dollar.

The first idea goes for a devaluation due to market jitters but the reverse could also happen as many would choose long-term US Treasury bonds as a safe haven, assuming that the turmoil would be temporary (as it is certain anyway). Speaking of safe havens, our minds also go to gold, but knowing that if the US dollar eventually rises, as it did in the corresponding crisis of 2011, gold could take a hit because it is known that a strong dollar rarely does it any good. We’ve clearly seen something like this in the last year and we have to keep that in mind. In the event that the dollar reacts bullishly, it is very likely that we will also witness a significant decline in the prices of various commodities.

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worry about it debt ceiling It may turn out to be an unnecessary alarm, which it most likely is. But the 25% chance given by the economists at JPMorgan Chase of the possibility of an “accident” is far from small. Although we believe that even if the deadline passes, the solution will be found quickly enough, we must not ignore the chaotic situation prevailing in American political life.

A few days ago the former president and now a new candidate Donald Trump He publicly urged Republican lawmakers to push things forward and force Democrats to accept several trillion dollars in federal spending cuts. Without calling for Kevin McCarthy to follow the example of the former president, we point out that understanding between the two major parties is more difficult now than it was in 2011.

So, for better or for worse, those in the equity markets would be wise to limit their risk, at least until the white smoke clears from the US capital.