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At IMF, Officials Warn of Major Fallout from U.S. Debt Debate

Officials and bankers are starting to take the threat of a U.S. default more seriously and begin contingency planning.

At the best of times, the mental gap between 19th Street, where policymakers debated global issues Thursday at the annual meetings of the International Monetary Fund and World Bank, and Capitol Hill, where U.S. lawmakers discuss more parochial matters, is much wider than the three miles that separate the two locations. But these are far from the best of times.

International policymakers and bankers looked on with growing dismay at the political drama over the U.S. government shutdown and debt ceiling taking place across town. If not resolved quickly, they warned, the dispute could trigger a global recession and permanently damage America’s economic pre-eminence and the dollar’s status as the global reserve currency.

“There will be very negative consequences for the U.S. economy and there would be very negative consequences outside of the U.S. economy,” said Christine Lagarde, the IMF managing director, at a news conference to open the annual meetings. She echoed comments earlier this week by the fund’s chief economist, Olivier Blanchard, who warned that if the Obama administration and Congress failed to raise the U.S. debt ceiling, “what is now recovery could turn to recession, or worse.” (Read more: “IMF’s Lagarde Urges Governments to Finish the Job of Financial Reform”)

Talk of default by U.S. lawmakers “just plays into the hands of those who say we need an alternative reserve currency,” Sanusi Lamido Sanusi, governor of the Central Bank of Nigeria, told Institutional Investor in an interview. “The U.S. has just shot itself in the foot.”

Talk of a potential compromise that would raise the debt ceiling for six weeks to allow negotiations over a broader deficit-reduction package lifted spirits on Wall Street Thursday but failed to impress among the IMF crowd. One notable exchange took place during a panel discussion of global economic prospects involving senior U.S. and Chinese officials. Jason Furman, chairman of the White House’s Council of Economic Advisers, used the forum to urge Congress to push the debt ceiling “as far out in the future as possible.” Yi Gang, the deputy governor of the People’s Bank of China, the U.S.’s largest creditor, quickly responded, “I hope what Jason said is true.” Earlier this week, officials in Beijing called on Washington to protect China’s investments in U.S. Treasuries.

This is not the first U.S. debt ceiling debate or government shutdown, and initially most international officials presumed this standoff too would pass. But as the days go on, officials and bankers are starting to take the threat of an U.S. default more seriously and begin contingency planning.

Although the U.S. Treasury may be able to continue to service its debt without raising the ceiling — a point on which the administration and some Republican congressmen disagree — it would have to slash other spending by some 4 percent of gross domestic product, virtually overnight, to eliminate the deficit, says Angel Gurría, secretary-general of the Organization for Economic Cooperation and Development. “Even without default, you would basically go into recession,” he predicts. The 34-nation OECD would also fall back into recession and emerging markets would experience “a sharp slowdown,” he adds.

A short-term debt ceiling extension may provide little relief, said Samir Assaf, head of global banking and markets and HSBC Holdings. “Everybody who has not worked on his contingency plan appropriately will do it seriously,” he told II. Among other things, that means looking at potential margin requirements for the trillions of dollars of U.S. Treasury bills and bonds that are used as collateral throughout the global financial system, he added.

Earlier Thursday, Hong Kong Exchanges & Clearing, operator of the city’s stock exchange, announced that it was increasing its haircut on Treasuries of less than one year maturity that are used as collateral to 3 percent from 1 percent.

However it is resolved, the escalating political crisis has already cast doubt on U.S. leadership, Nigeria’s Sanusi asserted: “Does America have the political will to do what needs to be done?”

Like Sanusi, Assaf said the U.S. debt standoff was likely to erode the dollar’s status and accelerate a shift to a multi-reserve currency world. “Anybody who’s sitting outside of the U.S. is thinking, ‘How can we get out of this trap?’ We can’t continue to rely on the U.S. dollar as a transaction currency and a reserve currency while no one has a grip on it,” he said.

Will the growing chorus of international criticism influence U.S. lawmakers? Probably not, say two U.S. academics. In a Washington Post column outlining the findings of a soon-to-be-published paper, Martin Edwards and Stephanie Senger of Seton Hall University found that the IMF’s widely publicized surveillance report on the U.S. economy, which came out just before the last debt-ceiling standoff in 2011 and called for serious medium-term reforms of entitlement programs and other spending, was almost universally ignored by Congress and the White House.

“Our findings suggest that the IMF has much to learn about how to better make its messages heard,” they wrote.

Read more in Banking & Capital Markets.

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