WELL, the US default has been averted. This is not a surprise to many who, from the very beginning, when the debt crisis negotiations started in earnest about six months ago, firmly believed that matters would never rise, or sink, to a default on payment of its obligations by the US government. There was just too much at stake.

A default — the first ever in US history, if you overlook the brief delay of some payments in 1979 due to technological glitches — could have lowered the AAA credit rating of the world’s leading economy; raised borrowing costs to the US government as well as to individuals for lifestyle requirements such as mortgages, car loans and credit cards; precipitated a 10 – 15 per cent fall in the US stock markets; undermined confidence in the financial markets around the world; and perhaps triggered a world-wide economic depression.

President Barack Obama signed a new debt ceiling bill on August 2, just hours before the US Treasury would have run out of borrowing authority. The debt ceiling was increased by US$2.4 trillion in two phases over the next ten years, thereby eliminating any possibility of default in that time. A similar amount of spending cuts must also be made over the same period.

Underlying issues in the debt crisis negotiations

These were two basic issues in the debt crisis negotiations: First, whether to Increase the ceiling or cap on the amount of money the US Treasury may borrow in order to pay off existing debt – financial commitments already made and secondly, to establish budget constraints that would cut spending, in order to reduce the shortfall of projected expenditures and narrow the deficit.

Deficit spending has long been the diet of the US Treasury. Congress has habitually approved budgets and programmes that required borrowing, including the current package. So now, the same Congress spent six months debating whether to give the Treasury the authority to borrow the money to pay for the expenditures they had previously approved. This is not the first time that the US Treasury has nearly run out of borrowing authority. Short-term extensions have usually been granted in the past through continuing resolutions that allow obligations to be met before the debt ceiling is raised by law. In fact, Treasury advised that the current debt limit had been reached in May, 2011. However, spending would continue through a series of extraordinary measures until August 2, Treasury said.

Debt ceiling history

The US debt ceiling facility was initiated in 1917 by the Second Liberty Bond Act, to help finance the country’s late entry into the First World War (1914 – 1918). The idea was to authorize a sum that would cover separate materiel and programs needed for the war, without requiring the Treasury to come back to Congress for separate approval each time. The first debt ceiling was about USD 40 billion. After 77 increases in 93 years (1917 – 2011), the ceiling is now USD 14.3 trillion.

Impact of financial crises on investor behaviour

The ways in which financial crises affect investor behaviour have been studied and are known to some extent. The spectrum ranges from nervousness to panic. One international analyst says that, so far, the current US debt crisis has been met, by and large, with, “confident anxiety.” While many investors were confident that the worst would not occur, some are still anxious about other likely fallout. Of course, there were also those investors who immediately got out of short-tern US Treasury bills and into longer-term ones or into other securities, into other currencies or other presumably safer parking places for their money. However, over the long-term, government securities are still amongst the safest investments available almost everywhere.

Exactly how each investor will react to a financial crisis depends on the type, horizon and objectives of the investor. Three basic types of investors have been identified: Savers, speculators and specialists.

Savers usually have a long-term horizon, usually 30 – 40 years and beyond. They are willing to accept low growth and relatively low return for the safety of their principal. They trade less and will diversify across other non-correlated, usually long-term asset classes. Savers rely primarily on time in order to reach their goals.

Speculators are always looking for an investment hedge that will give them a quick, higher than usual return. They have a short horizon as exemplified by the “day traders” who spring from their midst. Speculators rely on the next great investment idea in order to meet their goals.

Specialists usually focus on a single investment area and build their investment strategy around it. They work from a plan that seeks to attain goals over a six to ten year period, in the first instance. Specialists rely on their plan to achieve investment success in any market.

Generally speaking, savers and specialists, in that order, are better able to cope with the stresses of financial crises than are speculators.

Lesson to be learned

Forced compromises never solve problems. They only postpone the emergence of desirable solutions. In Washington DC, during the recent US debt crisis debate, the public got an overdose of elected leader bickering and gamesmanship. So much so that one analyst referred to the debate as a shameless display of petty partisan politics, which may have accounted for the fact that in one US national poll, 77 percent of the respondents believed that the elected officials behaved more like spoiled children than responsible adults. What the Americans would have preferred to have seen, the analyst concluded, was evidence of joint effort and willingness to solve a critical problem that faced the United States. There must be a lesson in this for elected politicians everywhere.

Gary Peart is the CEO of Mayberry Investments Limited. You can email him at gary.peart@mayberryinv.com.