The international impacts of the United States debt crisis are likely to be serious given the size of the US economy and its accumulated debt level. Other countries, including Australia, would need to expand their economies in an effort to offset the consequences of the US economy's decline, according to Charles Sturt University (CSU) economics experts.

 

Professor John Hicks and Dr PK Basu from the CSU School of Business in Bathurst say that in the most recent US-generated recession (known as the Global Financial Crisis, or GFC), Australia was able to do this because we were aided by policy action in China, as its response to the GFC, that saw the implementation of infrastructure projects which kept China's demand for our resource exports strong.

 

“But presently, the Chinese are fighting the demon of domestic inflation and may be reluctant to pursue expansionary fiscal policy with the same vigour, at least in the early stages,” Dr Basu said.

 

“Due to its domestic problems, the US dollar has weakened against all major currencies for the last few months. The Australian dollar is gaining value, which affects our exports, and in turn, the high-growth resources sector. As some experts suggest, the Australian dollar may rise to $US1.20 to $US1.25  in the near future due to the US debt crisis and recession.

 

“For our flourishing export industries it is not good news at all.

 

“Another factor that needs to be taken into account is the impact of the crisis on the value of US government bonds held by other countries, particularly by China, which is the largest single holder of US treasury bonds. Possibly China will be looking for alternate international sources of investments which may have severe consequences for the Chinese economy  and thus Australia’s. Australian holders of US government debt will also be faced with significant losses as the value of their holdings falls as new debt is issued offering higher interest rates than that paid on existing bonds.”

 

Professor Hicks explained that the present US debt crisis has arisen because the US government has to borrow regularly in order to fund the gap between its annual income and expenditure.

 

“In the last decade, the gap has widened significantly mainly due to two reasons: the substantial increase in defence expenditure due to the wars in Iraq and Afghanistan, and reduced tax revenues due to continuing recession in the domestic economy,” he said.  

 

“Each dollar borrowed adds to the US government's debt. However, a legislated debt ceiling exists, and once the ceiling is reached, borrowing has to cease temporarily unless the ceiling is raised further. Raising the ceiling is the normal response, and this has been done about 78 times since 1960. If the ceiling is not raised, and if an alternative flow of funds cannot be found, spending, equivalent to the borrowing required to fund it, would have to be curtailed.

 

“Other than defence expenditures, which cannot be reduced suddenly, government spending includes spending on government goods and services such as education, welfare, and health. It also includes interest payments on borrowed funds and debt repayment as borrowings fall due. This last component is very large for the US due to its extremely high accumulated debt. Also, failure to make the debt obligations would amount to the US government defaulting on its debt.

 

“Assuming that the ceiling includes government borrowing from the US central bank (the Federal Reserve System), options are limited – either increase taxes or reduced spending. Higher taxes would be deflationary. The US is regarded as an economy still in recession. Deflationary spending and taxing policies could cause recovery to stall and plunge the US back into an even deeper recession.

 

“An outcome appears to have been achieved with respect to the debt ceiling - but not without substantial costs. There will be a compromise legislated increase in the debt ceiling, but the conservatives of American politics, the Republicans, have insisted on massive spending cuts and no increase in taxes in return for raising the debt ceiling.

 

“Had the ceiling been raised without the restrictions imposed, borrowings could have continued at about current levels (of borrowing and interest) until recovery of the private sector permitted an easing of the growth of public expenditure. Instead, the government will be forced to pursue severe spending cuts. This may result in further economic downturn in the US.

 

“The counter argument is that adopting the Republican demands will stimulate private investment expenditure because the reduced government expenditure will signal lower future costs of private sector borrowing.