US heads towards meltdown (again).

Treasury Secretary Timothy Geithner warned it would happen. The Republicans warned it would happen. Obama warned of a shutdown, hoping that the media would just about buy it because that's what happened last time the Debt Limit expired amid the dispute between Clinton and Gingrich in 1995... but the US government could be about to default as well as shutdown.

Firstly, the reason why a shutdown is neccessary because it is the only way to service the treasuries interest burden without issuing new bonds- given that this is prohibited since their is no more headroom under the legally defined debt ceiling that Congress has failed to raise. In other words, all "deficit" spending- which accounts for about half of the US government's $4trn budget, will have to be eliminated immediately, by temporarily laying off staff and suspending less than vital services.

This will in effect remove 20% of the economy overnight. Whilst workers and benefit claimaints will still receive their checks, if the government stops spending money in the economy, the banks will run out of money to cash these with so they will in a sense become worthless. Inflation could jump significantly if workers and welfare receipients panick, especially if the shutdown is prolonged.

However, shutdown can only solve the problem temporarily. The treasury still relies on emergency financial measures, such as unsustainably raiding state pension schemes and cash reserves. They are quickly running out of emergency measures, and given the current state of Impasse in Washington they are quickly running out of schemes to prop up the debt. Up to this point Quantative Easing - financed by newly created money from the Federal Reserve bank - and organised by Goldman Sachs - has propped up the monster $2trn deficit. However, this has been done by using the new money to buy government debt. The only reason why the Fed is prepared to do this is because they receive an interest return. If the Treasury is prohibited from further borrowing then it follows that there can be no more QE, and stocks could start to plummet. The only alternative is a new type of "direct-QE" where the newly printed money is used to pay up front for government services, instead of buying long term debt. This choice would be rapidly inflationary, as the money would leak much faster into the economy. This would greatly disturb the global financial markets and herald a second coming of the Financial Crisis of 2008 that was only stopped from complete meltdownb by the intervention of government borrowing. That wont happen again in the current situation.