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World

Much rides on the US reaching a debt agreement

Democrats and Republicans have yet to reach a deal on raising the country's debt limit. Thus, the insolvency of the world's largest economy remains a possibility. Now China could increase the pressure.

A tattered U.S. flag is blown by the wind in Key West, Florida Friday Sept. 10, 2004. After enduring the passage of Hurricanes Charley and Frances, Florida is bracing for the possible arrival of Hurricane Ivan. (AP Photo/Dario Lopez-Mills)

USA Flagge nach Hurrikan Ivan

"Defaults on bonds would cause a pretty big earthquake in the global capital markets," Andrew Bosomworth, head of Pimco Germany, told DW. "US Treasury bonds are among the safest in the world. If that were no longer the case, the world of capital markets would be turned upside-down."

Taken to an extreme, the result would be a global financial crisis. "Equity and bond markets would crash, the external value of the dollar would fall," Bosomworth explained.

Pimco is part of the Allianz Group and is the world's largest bond investor. Pimco has invested around 1,500 billion euros ($2,034 billion) for its customers worldwide, says Bosomworth, and 220 billion of those euros are in the Germany portfolio he oversees.

Decision day

Bosomworth says uncertainty in the capital markets has risen since the beginning of the US budget freeze in early October. On the 17th of this month, the debt of the United States will reach a predetermined limit that can only be increased with the consent of the Republicans. If the disputing parties do not agree before that, the US would be rendered insolvent.

But there was some promise that a deal between Republicans and Democrats could emerge following talks between the party's leaders on Thursday (10.11.2013) and Friday. Even if the debt ceiling isn't outright raised, the deadline of October 17 could be pushed back somewhat.

"It is reported that the US government has about 30 billion dollars of liquidity. If true, the state would have money for another ten days after October 17," said Bosomworth.

The ability to plunge the world into a new financial crisis is certainly a trump card in the Republicans' hand concerning their ongoing dispute with President Obama on key political issues like the sweeping new health care law the president helped pass. But Bosomworth remains untroubled, saying, "I assume that both sides will reach agreement. Perhaps only after the 17th, but before it comes to defaults on bonds."

Rating agencies are immobile

Much of the financial world seems to agree. Although uncertainty can be noted in the stock and bond markets, panic is thus far absent. The major rating agencies have not yet thought it necessary to downgrade the creditworthiness of the United States.

Jens Boysen-Hogrefe, of the Institute for the World Economy in Kiel, sees little reason to question the US credit rating. "The country is not in a very deep recession. They actually have very good ways to deal with their special fiscal situation. They are indebted in dollars, the world's reserve currency, and they have a central bank that is willing to pitch in if it comes to that."

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Progress in US government talks

In other words, there are no economic reasons for a change in the rating, but possibly political ones. The head of Pimco Germany, Bosomworth, thinks that the rating agencies turn a blind eye when it comes to the United States. "If there were a budget dispute of this magnitude in Europe, the alarm bells would be ringing louder."

Unpleasant phone calls

However, the alarms beginning to sound elsewhere - in Beijing and in Tokyo. China and Japan are among the largest investors in US government bonds and the dollar. As such, they are key financers of American debt. It's unlikely they will idly observe the situation while political theater in the US potentially jeopardizestheir investments.

"The phone call the US Treasury is dreading would be a call from Beijing in which the Chinese secretary of state says that China will sell its dollar reserves," Bosomworth believes.

The finance expert says that would not happen immediately, as a hasty sale would also result in big losses to the creditors of the United States. But he regards it as likely for China and Japan to invest their money elsewhere in coming years. After all, China and Japan would only have two choices, Bosomworth says: "These countries will either need to increase the value of their currencies or peg them to other currencies such as the euro."

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