Still in crisis mode

German Central Bank President Jens Weidmann and German Finance Minister Wolfgang Schäuble were relaxed when they spoke with the press following the annual autumn meeting of the International Monetary Fund (IMF) and its sister lending agency, the World Bank, in Washington. That's because this time around, the burning issue for participants from 188 nations wasn't the euro crisis, as it was last year, but rather the financial row in the US.

Schäuble, for his part, had warned a year ago - at the last annual meeting - that euro bashing was getting old, especially since substantial progress had been made in the monetary union. But no one had really wanted to listen to him back then. Now, he hardly had to say a word.

At the three-day series of meetings in Washington, some 11,000 ministers, bankers and journalists who had gathered, as well as the global public, discussed how to solve the bizarre financial battle in the US. President Barack Obama and the Republicans still have not been able to reach a deal on the US budget and debt limit.

Earlier this month, the IMF's managing director Christine Lagarde said that continuing uncertainty about the US budget and debt ceiling is damaging international markets. The US government shutdown has not only paralyzed many of the country's federal agencies. Failing to allow a higher government borrowing limit would affect the American economy and seriously jeopardize the global economy, Lagarde said.

The US debt limit is currently at almost 17 trillion dollars (12.5 trillion euros). If it is not raised, the world's largest economy would officially go bankrupt this Thursday, October 17.

Will sound judgment reign?

Economists don't dare imagine what might happen then. International markets could collapse and the course of the dollar could go into freefall, as could the attractiveness of US government bonds. Rating agencies would automatically have to downgrade the credit rating of the United States to junk status.

The fact that US government bonds could then no longer be used as a deposit at the US Federal Reserve would be the least of the country's problems. The Federal Reserve has already started accepting junk bonds as deposits as part of its unconventional monetary policy. On the other hand, the situation would be more problematic for pension funds, for example, which are obliged to accept only bonds with a triple-A credit rating.

Still, most experts at the IMF/World Bank meeting scarcely believe US politicians would let the country go bankrupt.

"I still think it is unthinkable that an agreement won't be found," said Mario Draghi, head of the European Central Bank, noting similar standoffs in the past. "If this situation were to last a long time, it would be very negative for the US economy and the world economy and could certainly harm the recovery."

Schäuble and Weidmann also tried to remain optimistic in Washington, with the German finance minister saying that a solution "must be found."

Other experts said that simply raising the debt ceiling would not be a long-term solution. "Even without raising the debt limit, the US has significantly greater debt per capita than in the eurozone, or even compared to much discussed Greece," said Georg Fahrenschon, president of the the Deutsche Sparkassen and Giroverband (DSGV) - the umbrella group which includes state and savings banks - on the sidelines of the three-day talks in Washington.

'Unsustainable' fiscal policy

Not only is current debt per capita higher in the US than in Greece, it's also growing at a faster rate. A policy based on borrowing is not economically sustainable, Fahrenschon argued, saying it places a burden on future generations and obscures financial imbalances. Should the imbalances become too great, economic instability generally results.

Until now, central banks - primarily in industrialized countries - have attempted to prevent such instability or crises with a loose monetary policy, including quantitative easing and zero interest rates. But it's clear that this approach cannot continue indefinitely without the risk of future price bubbles or crises. "The central banks cannot keep their foot on the gas pedal forever," said Germany's central bank president, Weidmann.

Emerging markets must be on the watch

Last spring, outgoing US Federal Reserve Chairman Ben Bernanke had contemplated a shift away from loose monetary policy, which would likely spell a capital flight from emerging economies, but said it would depend on whether the US economy continued to recover. Recovery will be difficult if the government, whose spending constitutes nearly 20 percent of gross domestic product, remains in a deadlock.

Still, a change in fiscal policy must come about sometime - and emerging markets must prepare for it. "The eventual transition toward the normalization of monetary policy in the context of strengthened and sustained growth should be well-timed, carefully calibrated, and clearly communicated," the International Monetary and Financial Committee (IMFC) said on Saturday. IMF managing director Lagarde thus called on the world's central banks to work together to minimize the harmful effects of tighter monetary policies.