The Republican-controlled US Congress, the Democrat-controlled US Senate and the US President Barack Obama are playing a deadly “chicken” game with the issues regarding the US debt ceiling increase, tax raises and spending cuts.

The Republicans want to force the Democrats’ hands in not letting taxes be increased while initiating spending cuts; meanwhile the Democrats have declared dead-in-the-water any proposal that does exactly that. Neither House Speaker John Boehner (Rep) nor President Obama (Dem) has yet managed to find a middle ground acceptable to all parties.

With the August 2 deadline for raising the US debt ceiling or risking credit default looming, either party has to “swerve” or crash horribly into each other. This would have catastrophic consequences for both the US and the global economy.

Of course, the US govt has certain options – i) they could defer certain pension, servicemen salaries, tax refunds, etc. payments and avoid credit default; ii) they could coin trillion dollar coins (paper money circulation, unlike coinage, is fixed); iii) the president could, by dint of obscure/ ambiguous provisions of the 14th Amendment, force a debt ceiling raise – but they all make for poor policies and even worse politics.

There is actually one win-win (however non-rewarding) solution to such brinkmanship, that is – to concede, to compromise.

In true sense of the term “brink”, this compromise, I believe, will happen at the 11.59th hour. Meanwhile, creditors and investors will be made to sweat. The markets will be made to suffer.

The US cannot and will not default.

Update 1: The Democrat-led US Senate has blocked a plan to raise the nation’s debt ceiling and slash government spending, which was earlier passed by the Republican-led US Congress. The vote in Congress was a tough 218-210, with all House Democrats voting against. The vote in Senate was 59-41, including six Republicans voting against.

In a classic “strategic move”, the Senate Democrats threw out the steering wheel out of the window when they declared that any plan, that did not raise taxes and slashed spending, would be quashed, hoping this would force House Republicans to chicken out and swerve. But the House Republicans have remained resolute and drove straight, forcing the Senate to act, or as it turned out, to go straight as well and block the plan. This continued and heightened brinkmanship has pushed the US and global economy into further uncertainty.

The next moves will include more finger pointing, political grandstanding and frantic over-the-weekend deal brokering, punctuated by highly media-visible entreaties to the American People. Eventually, one can expect major defense cuts, some tax increases and a committee formation before the debt ceiling is raised, in some variant of Senator Harry Reid’s (Dem) plan … albeit at the last minute.

All the while, the markets across the globe will experience a stifling heat wave, as investors and creditors continue to perspire … profusely.

Update 2: The US Senate has delayed the vote on the debt crisis till Sunday afternoon – pushing the brinkmanship to further limits. Meanwhile, US Republicans are confident of being able to reach some form of a deal before the August 2 deadline.

To me, these are inevitable machinations prior to the compromise, brought about by the impending deadline and market, industry & public exasperation.

Update 3: It is August 2nd, 2001 in the US, it is the 11.59th hour for the US to raise the debt limit. The inevitable has happened.

US President Barack Obama has signed the bill to increase the $14.3 trillion debt ceiling. The US Senate passed the plan, which imposes sweeping spending cuts over the next decade, shortly after noon. The plan earlier been approved by the US House of Representatives.

As expected (and mentioned above), defense spending experienced the majority of the cuts. Contrary to what I had believed, no taxes have been increased nor new ones levied. In the chicken game, the Democrats blinked.

Having the final say in passing the plan in the Senate actually proved to be a disadvantage for the Democrats; since failure to raise the debt limit would have been seen as uncaring & reckless to the US citizenry as well as the rest of the world. It would have been, for the US, economically and for the Democrats, politically calamitous. This forced the Democrats to concede on major issues regarding tax increases, significant spending cuts as well as second-stage spending cuts “trigger”, should the debt limit be required to be further raised.

This piece succinctly highlights the pitfalls of the new plan. A plan that a lot of people identify as a far-from-perfect response to an artificially created crisis, that resulted in the US taking a beating in terms of its image of a safe haven for creditors’ money and trust. The impending credit ratings fall will not help matters and the global financial markets will be worse for it.

Lastly, a beautiful graph depicting who holds what portion of the US debt. Please be sure to check it out.