IEEJ: August 2011

Special Bulletin
A Japanese Perspective on the International Energy Landscape (53)July 29, 2011

U.S. Debt Ceiling Problem Shakes U.S. Economy, International Energy Situation
Ken Koyama, PhD
Chief Economist
Managing Director
Institute of Energy Economics, Japan

Various destabilizing factors always exist in the international energy market. But at thismoment, the most important destabilizing factor is fears over the future course of the world economy.
In this context, there are many destabilizing factors regarding the future course of the world
economy, including the Greek debt problem's possible spillover to major European countries andChina's inflation and asset bubble problems. Among them, the most serious problem at present is theU.S. debt limit hike and fears over the future U.S. economy.
In the United States, any change in the federal debt ceiling is subjected to Congressional
approval. The present ceiling stands at $14,294 billion as approved by Congress in February 2010.
As federal debt reached the ceiling May 16, the administration sent Congress a debt ceiling hikeproposal. Since then, a debt ceiling debate or battle between the Democratic and Republican Parties
has continued in Congress. Unless the debt ceiling is raised by August 2, the U.S. government isexpected to face the risk of default on its debt obligations. As no breakthrough has been made, evenup until just before the deadline, not only U.S. financial markets but also global markets have been
greatly shaken.
The U.S. government issues bonds to raise funds for servicing earlier-issued bonds. Unlessthe debt ceiling is raised, it may remain unable to issue new bonds and may default on its debt
obligations. In such event, U.S. Treasury bonds, which are the world’s most liquid and safe assets,with the top rating of Triple-A, may lose their creditworthiness and become subject to a rating
downgrade, exerting grave impacts on the world economy and global financial markets.
The ruling Democratic Party and opposition Republican Party have failed to reach acompromise on conditions for accepting the debt ceiling hike (at the moment this paper was written).
Specifically, their negotiations are deadlocked over how to structurally improve the federal
government’s debt-ridden budget over a medium to long term in exchange for the debt limit hike. No
breakthrough has come into sight at this moment. Structural budget improvement measures are
divided into revenue-boosting tax hikes and substantial spending cuts. Earlier, the Democratic Party
proposed tax hikes, facing harsh opposition from the Republican Party. Democrats later made someconcessions, coming closer to compromise with Republicans.

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IEEJ: August 2011

But the two parties have remained wide apart over spending cuts. While Democrats
proposed $2.7 trillion in budget deficit reductions over years and a debt ceiling hike of a similar size,
Republican House Speaker John Boehner came up with a two-stage debt ceiling hike – a first-stage
hike of $900 billion in exchange for $1 trillion in spending cuts and another hike contingent on
full-fledged, substantial spending cuts subject to negotiations next year. He has urged Democrats tocompromise with Republicans on the proposal. Complicating the problem is a group of conservative
Republican congressmen who have a strong aversion to big government and stick to large-scale
spending cuts. It may be difficult for Republican leaders to unite their party opinion. Prior to next
year’s presidential and Congressional elections, the two parties have had realistic and strategic
political disputes over the size and timing of spending cuts and ideological differences over
government roles, making it difficult for them to reach any compromise.
Fears of their failure to reach a compromise by the deadline, which could lead to the U.S.
government’s default and a Treasury rating downgrade, have greatly shaken the U.S. economy andfinancial markets. The Dow Jones industrial average on the New York Stock Exchange extended its
losing streak to the fifth day, hitting a one-month low of 12,240. As the default is expected to affectglobal confidence in the U.S. economy, the dollar has dropped below 78 yen/dollar. Fears over theU.S. economy have spilled over to the entire world, leading to a global chain of stock market
tumbles. While the battle over the U.S. debt ceiling hike attracts global attention, there areexpectations that a final compromise could be reached by August 2 to avoid any crisis. But no
optimism can be warranted.
Fears over the future course of the U.S. economy as the world’s largest and over the fallingcreditworthiness of U.S. Treasury bonds as the world’s most liquid and safe assets have shaken theinternational energy market as well. Economic trends symbolized by a stock market tumble are
expected to greatly affect U.S. and world energy demand. If the U.S. economic and financial market
turmoil deepens and expands, oil and other energy demand may slacken to shake the supply/demandenvironment for the international energy market. Perceptions about future energy demand can affectpricing on the energy futures market. Therefore, stock market tumbles and fears about economic
trends can work to lower crude oil futures prices.
Interestingly, however, stock market drops have not necessarily led to a fall in thebenchmark West Texas Intermediate crude oil futures price in the last few days. On July 28, forexample, the WTI futures price gained $0.04/barrel to $97.44/barrel even amid the stock market
decline. Behind such development were the dollar’s depreciation and its impacts. As dollars havebeen sold on falling confidence in U.S. government securities and the U.S. economy amid the debt
ceiling hike battle, money might have flowed into markets for commodities as real assets. In thisrespect, prices of gold viewed as a safe asset have rewritten records. The benchmark crude oil
futures price basically followed a downward trend amid the stock market tumble over the past fivedays. But it closed higher in three of the five days. In this sense, the crude oil futures price’s2

IEEJ: August 2011fluctuations amid the shaken financial markets have been very complex.
In this context, we can expect crude oil prices to remain excitable with regard to financial
market developments. If the U.S. debt ceiling problem deepens further to add fuel to fears over thefuture course of the U.S. economy and the world economy, crude oil prices may basically comeunder great downward pressures. We may not be able to keep our eyes off U.S. financial markets forthe immediate future.
Contact: report@tky.ieej.or.jp

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