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U.S. debt showdown: What happens on Aug. 3?

U.S. Capitol building in Washington, D.C.

MOLLY RILEY

As the clock ticks inexorably toward the deadline set by the Obama administration for raising the debt ceiling, collars are tightening in Washington, capital markets are becoming more volatile than usual and pundits of all political stripes are ratcheting up the hyperbole. To hear some of them tell it, the financial world as we know it will come crashing down if there is no debt deal by Aug. 2. In fact, it will be over if there is no political solution by Wednesday, because the deep thinkers in Congress will need a few days to pass the necessary legislation.



There is no question that Washington needs to fix this ridiculous problem of its own making. Nor is there any doubt that neither the Republicans nor Democrats will emerge from this fiasco looking better in the eyes of an already deeply cynical electorate, regardless of the outcome.



Until this past weekend, the markets were fairly sanguine about the whole debt limit contretemps. Investors kept piling into U.S. Treasuries and assets, in large part, because there really isn't any place else for risk-averse major institutional investors to go, once they have had their fill of gold, Swiss francs and Canadian bonds. But after the latest Republican antics and tough talk from the White House about vetoing any short-term debt solution, it is far less certain that insaner heads in Congress will be overruled.

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The administration never should have tied the ceiling issue to a vastly more complex two-year deal on the deficit, but that horse has already left the barn. Now, the administration has to live with a short-term fix for the immediate problem; and the more reasonable voices in the Republican ranks need to persuade the Tea Party types that compromise is an essential part of the political game.



But let's say both sides continue playing what Warren Buffet calls a dangerous game of Russian roulette until it's too late to meet the deadline. The U.S. will not be destitute on Aug. 3. Nor is it likely to miss a single payment to bondholders. Existing tax revenues will cover more than half the government's expenses of about $3.8-trillion (U.S.), including its most pressing obligations - from interest on the debt to social security, Medicare and military expenditures. The Federal Reserve can also dip into its hoard of about $2.6-trillion worth of Treasury bonds and other securities on its balance sheet to absorb whatever extra money the Treasury has to print. And the Treasury itself holds billions worth of mortgage-backed securities from Fannie Mae and Freddie Mac, as well as close to $400-billion in gold that it could sell or swap with the Fed.



Well before it needs to tap such emergency sources, the government could start shutting down departments and services and shelving transfer payments to the states on a temporary basis. Maybe closing a few offices in key congressional districts would get the politicians off their high horses and back to the negotiating table, where they belong.

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About the Author
Senior Economics Writer and Global Markets Columnist

Brian Milner is a senior economics writer and global markets columnist. In a long career at The Globe and Mail, he has covered diverse business beats, including international trade, the automotive industry, media, debt markets, banking and the business side of sports. More

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