American Debt-Ceiling Crisis Essay Example

decrease in revenue and a decline in their share market. When global share markets decline, individuals may become concerned about their investments and choose to withdraw their funds. They look for a relatively stable economy like Australia as a safer investment destination.

The US debt-ceiling crisis concluded on August 2, 2011, with an agreement reached to increase the debt ceiling and decrease future government spending. The current debt ceiling is set at 14.3 trillion dollars, which determines the government's borrowing limit (Mother Jones reporting staff, 2011). In just four days after this resolution, US government bonds experienced their first-ever downgrade in American history, losing their AAA credit status. The discussion surrounding the debt ceiling and debt reduction continued until July's end. This essay will examine the American debt crisis and its impact on Australia's Capital Market in three sections: introducing the issue and its effects on Australia; focusing on the recent downgrade of US credit rating and disagreement over raising the debt ceiling or reducing expenditure; discussing how both America and Australia's economies as well as their respective debt markets are affected.

The American debt-ceiling crisis arises from the government's expenditure exceeding its tax earnings, which necessitates borrowing money. This gap has widened due to increased defense spending resulting from the wars in Iraq and Afghanistan and reduced tax revenues during a domestic recession (Hicks, 2011). The US debt pertains to funds borrowed through Treasury securities and other federal agency issuances. US law imposes a specific debt ceiling that restricts how much the Treasury can borrow, necessitating approval from Congress (US government accountability office, 2011). However, on May 16, 2011, the Treasury Secretary

informed Congress that the government had reached its $14.294 trillion debt limit. Consequently, an increase in the debt ceiling was necessary to continue borrowing for current spending levels. Failing to raise the debt ceiling would have resulted in an immediate 40% reduction in spending with significant implications for domestic and international economics and potential default by the US (Geitner, 2011). As a result, there has been a contentious debate regarding increasing the debt ceiling.

The argument in this text highlights the importance of increasing the debt ceiling to prevent disruptions in the capital market related to treasury financing. According to Matthew E. Zames (2011), failing to raise the debt ceiling could lead to a Treasury default, which would have severe consequences for the $4 trillion Treasury financing market and cause borrowing rates to sharply increase for some market participants. Treasuries are widely recognized as the safest asset globally and commonly used as collateral. However, a default would undermine confidence in this collateral and result in a significant decline in lending. Therefore, it is crucial to raise the debt ceiling and avoid defaulting on existing debt.

To meet its current debt obligations, the government must pay interest and principal on treasuries and bonds when they mature. Failure to raise the debt ceiling would result in defaulting on these existing debts, causing countries like Australia to lose trust in the US government and become less willing to provide future funds (Kalen Smith, 2011). Timely payments on treasury securities are crucial for maintaining trading relationships with other nations. The opposition to raising the debt ceiling crisis primarily arises from concerns about devaluing the dollar in capital

markets.

Although there are immediate benefits to this strategy, it could also have long-term consequences. The depreciation of the US dollar and heightened instability may elevate the likelihood of defaulting on existing debts, ultimately reducing the global reserve currency status of the dollar (Kalen Smith, 2011). Additionally, this situation could lead to inflation and significantly affect the prices of food and oil. It is essential to instill confidence in the international market without resorting to price increases.

A decision to not raise the debt ceiling can demonstrate to the international market that the US acknowledges their issue and intends to decrease excessive spending (Kalen Smith, 2011). Conversely, raising the ceiling could be interpreted as a sign of deepening the hole. Consequently, the global community would be content with the choice to maintain the current debt ceiling.

The United States federal government's credit rating was downgraded by Standard & Poor's from AAA to AA+ on August 5, 2011 (Robert Peston, 2011). This marked the first time the US had experienced a downgrade. Consequently, foreign investors may lose trust in US treasuries, which are traditionally seen as risk-free due to the constant default risk. As a result, higher interest rates may be imposed on US debts, potentially exacerbating the debt issue. The BBC commentary suggests that implementing international supervision of the US dollar and considering a new globally stable and secure reserve currency could help prevent any potential catastrophe caused by an individual country. The overall impact of this downgrade on Australia remains uncertain.

According to PK Basu (2011), the Australian export industry is being affected by the strengthening of the Australian dollar compared to

the US dollar. This appreciation also has consequences for Australian investors who have substantial investments in US government debts, as the value of these investments decreases due to higher interest rates on new debt issuance. In the next sections, we will conduct a more detailed analysis of how this situation is impacting Australia's capital market. Part 2

The Budget Control Act of 2011, signed by President Barack Obama, has had a significant impact on the United States economy. It includes an agreement to cut government spending, which could result in high unemployment and low consumer demand (Patrick Lunsford, 2011). This may lead to a decrease in GDP and slow down economic growth. Additionally, a credit ratings downgrade may encourage a deficit-reduction plan with substantial program cuts (Steve Bell, 2011). These factors contribute to the increased influence of the Budget Control Act of 2011 on US economic growth. The question arises: Can Australia withstand these effects?

According to Professor John Hicks and Dr PK Basu (2011) from the CSU, the US debt crisis, which holds the title of being the largest national economy globally and dominating the global financial market, will cause instability and a decrease in worldwide economic growth. This impact extends to Australia as well. The professors also noted that this crisis will significantly affect the size of the United States' economy. Although Australia can counterbalance this decline by expanding its economy through trade with China, it will still suffer consequences if there is a continued weakening of the US dollar. This weakening would lead to an increase in the value of the Australian dollar and further reduce export income. Nevertheless, there

are factors that can help alleviate this impact.

Australia can protect itself from the repercussions of the US debt crisis by focusing on its relationship with China. Given that China is a global growth leader and a significant consumer of Australian resources, Australia has an advantageous position. According to the Australian Bureau of Statistics (ABS, 2011), economic indicators reveal that China is the second largest market for Australian excess exports, representing 25% of total exports. In contrast, the United States faces challenges with one of the largest trade deficits. Consequently, if Australia overly relies on the United States, it could hinder its own economic progress.

Despite the decline in the exchange rate between the Australian dollar and US dollar, Goldman Sachs has revised down its forecast for Australian GDP. They believe that earlier this year, the Australian dollar reached its highest position in 30 years and that demand from Asia remains strong. As a result, they expect continued growth of the Australian dollar in the coming year. This growth, along with an interest rate cut in November, supports Goldman's belief that consumer demand is weak and economic growth is slowing down in Australia. Additionally, Australia's strong currency has prevented desired profits from trading with China to offset the impact of the US debt crisis on its economy's growth. The debt market has also been affected by this situation.

American Treasury Security Selling out US Treasury Bonds? The downgrade of US’s credit rate from AAA to AA+ by Standard ; Poor's theoretically means a higher default rate, posing a threat to the holders’ asset safeties due to the increased risk. According to the

U.S. department of the treasury’s resources (2011), it appears that China, the largest holder of American treasury securities, reduced its holdings from 1173.5 billion US dollars to 1137 billion during August. The safest way.

China spent more on corporation bonds instead of US treasury bonds, as selling treasury securities can cause depreciation and harm the residual value of the bonds. Additionally, it can lead to a decrease in the value of the US dollar, making the RMB more expensive and impacting Chinese exports, which is crucial for employment rates in China (Frank Langfit, 2011). On the other hand, Ryan (2011) argues that American Treasury bonds are still the safest investment and that there is no need to worry about downgrading due to the lack of credibility in credit rating agencies. Steve Bell (2011) also confirms Hill's belief that investing in Treasury bonds is the safest option to observe the impact of downgrading.

According to Mohamed El-Erian (2011), the US dollar's role as the global reserve currency and its reputation as a safe haven for other nations' earnings will be weakened. The U.S. department of the treasury (2011) reports that this has led to a significant decrease in long-term US treasury bond yields after the debt ceiling was raised. The decline in yield suggests that investing in treasury bonds is seen as less risky rather than more risky following the downgrade. Furthermore, countries such as Japan, United Kingdom, and Switzerland have increased their holdings of US treasury securities (U.S. department of the treasury, 2011).

Australian Prime Minister Julia Gillard disagreed with the downgrade of the United States' AAA rating by Standard & Poor.

She noted that Moody's and Fitch had maintained the rating (CNN, 2011). Despite a decrease in Australian holdings of US treasury securities in August 2011, Australia has increased its investments in both treasury bonds and corporation bonds. Additionally, Australia has one of the lowest debt profiles among developed countries (Julia Gillard, 2011), and its AAA credit rating can help lessen the impact of the American debt crisis. The Australian Economic Indicators from November 2011 indicate a noticeable decline in interest rates for Australian treasury bonds during August and September, suggesting a growing preference for holding these bonds.

The downgrades of US American debt crisis in the share market will lead to a loss of confidence in American companies. People may become afraid of losing their invested money in the US share market, causing them to stop buying shares. Sellers will reinvest their shares in economically stable countries. Additionally, due to uncertainty surrounding the debt crisis, people have become sensitive to share price fluctuations and tend to overreact. This has resulted in a sudden drop in share prices in August. Share prices reflect future expectations of cash flow, and when people no longer expect positive company performance, they sell their shares. As more people sell, the share price continues to decline until someone is willing to buy. This decline in share prices reduces a company's market value of equity and increases the debt-to-equity ratio (d/e). Borrowers become concerned about lending money to companies and may withdraw their funds, leading many companies to go bankrupt. This worsens the situation and intensifies fear, prompting more people to sell their shares. The global effect is widespread.

The

global financial crisis in the United States had a significant impact on various countries, particularly China. In August 2011, the US credit rating was downgraded by S&P from AAA to AA+. This downgrade directly affected China's foreign exchange assets as about two-thirds of their reserves are held in US dollars. Moreover, being the largest creditor nation to the United States, China faced decreased demand for its export products due to the weakened American economy. Additionally, extensive money printing in the US caused depreciation of the US dollar and subsequently increased prices of commodities denominated in dollars. Consequently, Chinese companies experienced reduced revenue which ultimately impacted China's capital market share price.

The decline of China's economy, which is Australia's main economic support country, will affect its demand for Australia's mining resources. This will result in a decrease in Australia's revenues and share price. As a consequence, the movement of Australia's share price reflects that of the US. Although there might be a slight delay in the Australian stock market compared to the global stock market, electronic transactions and the internet facilitate rapid news dissemination worldwide, thus stimulating most transactions in the global stock market.

The debt crisis has caused uncertainty, leading to a higher sensitivity towards share prices in the capital market. Consequently, individuals are opting to move their funds from the US to Australia as a promising investment option. [pic]

The trade volume in ASX increased significantly in August, while the trade volume in S;P experienced a significant decrease in the same month [pic]. Analyzing the chart below shows that price changes in the Australian stock market were not as drastic as

those in the global market after August. Nevertheless, Australia's share price is still declining, although it is less affected compared to the global market. This could be due to investments being made within Australia, which helps lessen the impact of the global share market on the country [pic] (The Wall Street Journal, 2011).

The US economy could potentially be rescued by the implementation of QE3, which involves the Federal Reserve using various tools to stimulate the economy (ringleader, 2011). These tools may include purchasing more Tbills or providing financial aid to banks once again. Recently, there has been a shift in strategy aimed at reducing long-term interest rates by selling shorter term notes and acquiring longer dated maturities (Mark, 2011). This approach is effective because American short term notes are highly liquid assets. Individuals have limited alternatives and are compelled to invest in other assets, allowing the government to lend money with low interest rates to local companies for extended periods. However, it remains uncertain whether QE3 will yield desired results. While QE3 is not currently being utilized in the US, Asian stock markets have recently experienced significant growth on Monday as investors engage in substantial buying activities following Wall Street's surge on Friday. As a result, there are signs of recovery within the share market.

The US debt ceiling crisis has had a significant impact on both the domestic and international financial markets. The crisis concluded with a difficult compromise of increasing the debt ceiling and reducing future government spending. This compromise, along with the downgrading of the US credit rating, negatively affected the country's confidence in the international capital market and

slowed down global economic growth. As a result, there was increased interest in holding US treasury bonds for asset protection. However, Australia's stable economy makes it an attractive investment option during economic downturns, helping mitigate the global economic impact. Charles Sturt University (CSU) economics expert recommends that Australia should focus on expanding its economy to offset the consequences of the decline in the US economy. Additionally, maintaining a certain inflation rate is important for Australia to ensure economic growth and stability, making it appealing during global financial crises.