Christine Lagarde: Raising the U.S. Debt Ceiling is Critical

Washington DC

Christine Lagarde, the managing director of the International Monetary Fund, offered her opinions on the American government stalemate and its impact on the rest of the world, Bloomberg reports.

Lagarde was critical of the U.S. government for its inability to reach a compromise, resulting in the partial shutdown that has been leading the headlines this week. What she was really concerned about, though, was the possibility that the U.S. could default on its debts.

The date whereby the U.S. government has to either agree to raise its debt ceiling or face an inability to pay off its obligations is set on October 17, less than two weeks in the future. If Republicans and Democrats cannot reach an agreement in which the debt ceiling is raised above $16.7 trillion, the Treasury Department will not be allowed to issue additional bonds and certain payments will have to be suspended.

Whether these are bond interest payments, social security payments, or day-to-day operating expenses is yet to be determined. Only because of so-called “extraordinary measures” has the government been able to continue making payments since May, when the ceiling was officially reached.

The last time that the debt ceiling had to be raised — just two years ago – a failure to resolve the situation until the last minute meant that markets lost a substantial amount of ground. Lagarde expressed worries that a similar scenario could transpire this month, except that more would be at stake than U.S. markets.

As a debt default increases in probability — even if the chances are still relatively quite low — the odds go up that the U.S. will have its bonds downgraded by an additional rating agency. In addition, investors will demand higher interest rates for bonds.

This has two potentially disastrous effects. It decreases the value of bonds currently being held by banks, forcing them to take a substantial loss, and it makes it more difficult for nations across the world to borrow, as their bond rates are pegged to U.S. rates. This, in turn, could increase the cost of borrowing across the globe.

Lagarde also commented on the state of economies across the world. She spoke on the impact of the U.S. Fed’s decision not to taper quantitative easing, claiming that, while the choice was ultimately helpful to emerging markets, the very uncertainty over the matter caused shocks to several currencies of developing countries. She called for greater clarity in communication between the Fed and the markets in order to remedy the problem.

Lagarde had good things to say about Europe, praising the recent beginnings of an economic recovery and pointing to the possibility of real economic growth starting back up in 2014. However, she took caution in mentioning that the turnaround was conditional on the U.S. government raising the debt ceiling in a timely manner.

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