Keep calm and carry on

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Sun Media, Friday, July 15, 2011

We'll be hearing a lot in the coming days about Article 4 of the 14th Amendment to the U.S. Constitution, which stipulates: "The validity of the public debt of the United States... shall not be questioned."

This could be Barack Obama's constitutional trump card in his staredown with congressional Republicans over the impasse on raising the U.S. debt ceiling, which has already exceeded its legislated limit of $14.3 trillion.

That is not a typo. And it's not Greece. It's America.

This is where the IFIs, as the international financial institutions are known, usually show up and ask for the keys to the car. Not to mention the house.

The U.S. debt is forecast to exceed 100% of GDP next year. By comparison, Canada's debt-to-GDP ratio is one-third of output, by far the best in the G7.

The current U.S. deficit alone of $1.6 trillion is 10% of U.S. output. Stated another way, the U.S. deficit is larger than the entire economy of Canada.

Except Canada's current deficit is less than 3% of GDP and is cyclical, caused by the financial crisis and the Great Recession of 2008-09. Canada will return to fiscal balance in three years.

The American deficit is structural, with no prospect of it being eliminated in this decade. Or, truth be told, in the next.

This is at the heart of the argument between Obama and the Republicans, who have been captured by the Tea Party movement.

In return for raising the debt ceiling by $2 trillion, Obama is offering at least $2 trillion and as much as $4 trillion in cuts to the deficit over the next decade.

And there's the devil, in the details.

Where to cut?

Social Security, the U.S. equivalent of the Canada Pension Plan?

Medicare? Defence spending? Bridges to nowhere?

You can see where this goes. Nowhere.

Then what?

If no agreement on raising the debt ceiling can be achieved this month, then the U.S. government will be unable to pay its bills next month.

In Canadian terms, treasury and supply will not be approved. Could the U.S. default on its debt?

Not likely.

If that were the case, U.S. treasuries would be trading in Greek territory, 17% for 10-year notes. Sovereign debt as junk bonds.

But in the event global markets were jittery on the prospect, which could trigger another global financial crisis, Obama would have the 14th Amendment to fall back on.

His treasury secretary, Tim Geithner, has already made this clear.

Which is one of the reasons the markets haven't been freaking out on the prospects of a U.S. debt meltdown.

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