The US shutdown and debt ceiling issues have been hogging economic and financial news headlines for the past few weeks. Our clients have asked us how the two are intertwined. The shutdown and the debt ceiling are in fact two separate issues, which are being linked politically.

The shutdown emanates from the failure of the US Congress to fund government operations. The current federal government shutdown commenced on October 1, 2013, the main issue being the dispute between the House of Representatives controlled by the Republicans and the Obama-controlled Senate over the delaying of the Affordable Care Act. As of the beginning of this month, non-essential services were suspended and non-essential workers furloughed.

The debt ceiling is a statutorily imposed, maximum amount of debt a country is allowed to write. The US and Denmark are the only democratic countries with such a ceiling written into their laws. The current ceiling in the US stands at $16.7 trillion and the last major movement to this figure occurred in January 2012, when it increased by $2.1 trillion – another impasse was averted this past New Year’s Eve with the passage of the American Taxpayer Relief Act: the end of the “fiscal cliff” saga.

While in Denmark the debt ceiling law is treated as constitutional protocol, in the US it is used as a chance for political manoeuvring. That the two issues are being linked is a matter of timing. The US fiscal year end, and the date the US Treasury Secretary forecasted when the debt ceiling would hit, fell very close to one another. The Republicans saw the looming debt ceiling as an opportunity to go one up on Obama.

The debt ceiling was reached last May and the Treasury has been taking “extraordinary measures” such as delaying payments into pension funds to keep paying its bills. These measures will be exhausted today, October 17. Missing this date by a few days will not be a calamity in itself as the Treasury would still be left with $30 billion cash in hand; along with other inflows such as tax revenues, this should see it through until the end of the month.

A US default could be a disaster, and will plunge the world into unknown territory. A default of this size, and by the quality of this issuer, has never been tested before

The coffers will run dry however by November 1, with payments of circa $67 billion in respect of social security and other benefits and reimbursements. Unless the debt ceiling is postponed or increased by this date, the Treasury will not be able to move forward with massive net debt issuance settling end October. Beyond this date – should no solution be found, the US might default on its debt.

Hence there are three possible scenarios going forward:

• Congress agrees a solution by today (I am writing this article on October 15, so here’s me hoping a solution has been found!);

• A deal is agreed in the next few days, but before the US defaults on its payments.

These two scenarios are the most likely outcomes. A third scenario – that of a US default – could be a disaster, and will plunge the world into unknown territory.

A default of this size, and by the quality of this issuer, has never been tested before. A recent Bloomberg article noted that at 23 times the debt Lehman defaulted on in 2008, a US default would devastate global stock and debt markets, ravage the dollar and throw economies worldwide in disarray. A default of this size will also freeze other markets, including repos and other derivatives where US treasuries figure heavily as the underlying collateral. Banks will have to write down securities on their books, causing strain on stretched balance sheets. In the months post the Lehman collapse, the Treasury used all its powers to prop up the banking system; a bankrupt sovereign will have no money to disburse.

Markets seem to be pretty sanguine to the looming apocalypse – 10-year US bond prices have actually gone up over the last few days. To be clear, I too believe that a solution will be found; however, it is worth noting that bond prices did not forecast a Lehmans default either – 10 days before the bank collapsed, its bonds were still priced at 95 per cent and upwards.

This article is the objective and independent opinion of the author. The information contained in the article is based on public information.

Curmi and Partners Ltd is a member of the Malta Stock Exchange, and is licensed by the MFSA to conduct investment services business.

Vincent Micallef is an executive director at Curmi and Partners Ltd.