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http://ca.news.yahoo.com/why-canadians-care-u-default-210220020.html

Why Canadians should care about a U.S. default

CBC – 7 hours ago

When even the U.S. Treasury refers to the possibility of a debt default by the

American government as " an unprecedented event in American history that would

precipitate another financial crisis, " that tends to get the world's attention.

The doomsday scenario is certainly scary: A default causes global interest rates

to soar as debt priced in the world's most liquid currency comes to be regarded

as more risky, banks become more reluctant to lend — even to each other — and

debt, the lifeblood of business investment, becomes less available.

As well, stock markets sell off and plunge the world into another recession.

And Canada, as an exporting country doing three quarters of its trade with the

U.S., would share in that pain.

" The nuclear option, " Buchanan, senior economist at CIBC World Markets,

told CBC News, " is certainly something one doesn't really want to think about. "

But whether the sky will fall on Canada if lawmakers in its biggest trading

partner don't manage to do a deal on raising their debt ceiling, cutting

spending and lowering taxes is far from certain.

It depends.

A default is a problem if lenders lose confidence in the borrower's ability to

pay back what it owes, refuse to lend it any more and the country runs out of

money.

A key element of this debt showdown is no one knows how seriously financial

markets will interpret a statutory default.

" We're really in some sense dealing with unknown waters, " said Buchanan. " The

U.S. has never defaulted on its debt before. "

" There's no doubt that it would have serious repercussions, " he said, but

whether it would lead to another financial crisis is uncertain.

" Whether it would lead to a Lehman moment (a reference to the collapse of Wall

Street investment bank Lehman Brothers in 2008) or not, I think it could, but

we'd have to see. It's not something markets have had a great deal of experience

with. "

" There have been many, many experiences of sovereign defaults through history, "

said Schwerdtfeger, a senior economist with TD Bank Financial Group, " but

none of these have been so significant as a U.S. government default could be. "

But Schwerdtfeger expects the effects of a default would be limited. " It's not

that the markets have completely lost faith in the U.S. and its ability to repay

debt, " Schwerdtfeger said.

" We would expect that that situation would be corrected within a matter of

days, " he said, " because there is room for credit rating agencies not to assign

a rating to all U.S. debt but just to one debt issue (if it's in default). And

then that could be corrected once the U.S. made the (interest) payments. "

Still, both economists agree a default would lead to higher short term interest

rates. Because U.S. Treasuries are regarded worldwide as the safest debt

anywhere, global bond markets would demand higher interest to reflect the

increased risk of all debt, including Canadian bonds, but Schwerdtfeger believes

the effects would be limited.

More than a default, which he believes in unlikely, Buchanan worries a deal to

avert a default will include sharp spending cuts, a troubling possibility given

that federal spending accounts for eight per cent of the American economy.

" That could weigh quite a bit on an already weak economy, " he said, given the

June employment numbers disappointed economists, showing job creation of just

18,000 compared with the 90,000 new jobs most had expected.

A debt limit agreement that included cutting $2 trillion in spending, Goldman

Sachs economists have said, could shave 0.8 percentage points off economic

growth next year.

" If the U.S. economy slows further or even lapses in recession that would have

clear implications for Canada's economy given that about half our GDP is

trade-related and three quarters of our trade is with the U.S., " Buchanan said.

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