My point is that a Greek default is now becoming a foregone conclusion and therefore causes systemic problems as people start to worry about the solvency of Greek banks if they hold Greek bonds and therefore whether Greece can stay in the euro area with a growing economy given that it has had inflation that has been far above its partners for a significant period of time. The US is just not in that position and although some in the Tea Party and for that matter in the UK Conservative party appeal to the example of Greece as a reason why the US and the UK need to really tighten the fiscal screws, the logic frankly just doesn't carry over, and there are several reasons for this which I details below.
First, even if the political parties run out of time and cannot strike a deal, a US default is just not a foregone conclusion yet - as the FT made clear in an excellent article yesterday, the 14th Amendment of the US Constitution states that “the validity of the public debt of the United States ... shall not be questioned”. The Supreme Court, in a case back in 1933 when the US was trying to escape paying its gold obligations after it left the gold standard, stated that Congress has to honor it's own contracts, and that that means that the interest payments must be made, whatever else might happen. So that implies that, quite simply, a default cannot happen, and that cuts will have to be made to government to hold spending down so that it does not exceed revenues. If Congress is obligated to pay certain payments then presumably the President must have some role in declaring that Congress is out of order and breaking the law and can issue an executive order to raise the debt limit.
Second, there are other (rather "clever" and obscure) options, described in the excellent piece on the CNN website by Jack Balkin. I rather like the idea of asking the Fed to issue 2 jumbo sized platinum coins worth $1 trillion each - which can then be credited to the government's account!
But let's get to the "Armageddon" option of a default - some now think that it's not such a remote possibility, and have looked at probabilities of what could happen and the implications of this. Perhaps the most publicised analysis over the last 24hrs has been that of Willem Buiter (who used to teach me when I was a graduate student) and Ebrahim Rahbari of Citi which was neatly summarized in the FT Alphaville today. Although a downgrade is clearly not going to be good news for future borrowing or rollover of the current stock of debt, the 2 economists do some serious "back of the envelope" calculations that make clear that GDP would not fall by a third, and that by their calculations the amount would be between 0.2 to 0.5% fall. Now noone wants GDP to fall given the fragility of the current recovery, but that is a far cry from the 5% fall predicted by Credit Suisse. In their research Buiter et al put weights on 5 different scenarios and they got them a little askew (in my humble opinion), as given the politics, the one now most likely is a debt default, not Scenario 1 ( - no default as a bill is passed by Congress). Plus there is another scenario which I will label Scenario 6: "The Federal debt ceiling is not raised in time and the US sovereign does not default". This might come about because of some obscure legal manoevering (see above) that the White House might be able to manage, and although it might trigger a downgrade due to the market impression that it is "kicking the can down the road", it may nevertheless be a feasible option.
So what will happen in the event that things don't go well next week? If a political deadlock with no obvious escape means that fiscal policy puts a break on US growth, the Fed is still able to swing into action with a QE3, something that might be necessary if the legality of the President's options is questioned. So I think the prospect of the US stockmarket falling by 30% is just not grounded in reality - and certainly not for any sustained period of time.
I think that a default and downgrade is now the most likely scenario, but I also think that there is an understanding in world markets that this is not a reflection of an unhealthy US economy, this is just a reflection of the dysfunctional politics that the US now finds itself in, due to the Tea Party. There is one silver lining to all the hysteria of recent days though - at least a public debate is now starting to happen in the US as to what should be done - and that, I believe, is a positive outcome.