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Deep Breaths For The Next US Debt Stand-Off

Last week I wrote that the rest of 2013 would be dominated by 3 crises - Syria, Emerging Markets and the return of the Eurozone crisis.

Unfortunately it looks like next month we may have to add a fourth crisis to that list.

This week the US Treasury secretary Jack Lew fired a shot at Congress warning them the US would run out of money to pay its debts, if it did not increase the National Debt limit above its current limit of nearly $17 Trillion.

All of this happening in an economy showing solid recovery and whose recent growth figures keep being revised upwards.

So while the US may be a private sector success story, but it is a public sector disaster.

The forthcoming US debt and budgetary crisis is part of a multiyear (decade?) paralysis between Democrats and Republicans which has been, and feels, endless.

This legislative paralysis is mirrored across much of the country, where for years politicians have ensures re-election by promising elaborate public pension sector pensions and benefits - which will fall due long after politicians retire!

This reckoning is starting to happen now, as we saw in Detroit, with many other cities and states lined up behind it.

At the front of this queue is Illinois (which contains Chicago, the largest US city after New York and Los Angeles). Illinois spectacularly owes two and half times more in pensions that it has in its pension pot. There is not a snowballs chance in hell this can be paid. Its firemen, nurses and teachers face massive pension cuts in the years ahead.

The key point here is that the current US debt ceiling discussions do not contain any acknowledgment or provision for these enormous unfunded state and city pension liabilities (never mind solution). The federal government will, in all likelihood, suffer the bill.

As I have written elsewhere, the US is far from alone here. In fact, it in a better state that most of the G20 economies. In Ireland (where I live) the government has unfunded public sector pension liabilities equal to 4 times the country's GDP! None of this is included in its already dire National Debt figures (of approx. 130% of GDP).

The US debt ceiling crisis will be played out against a background of imminent monetary tightening by the Federal Reserve. This will increase interest rates and while it was always going to happen sooner or later, higher rate expectations are already being reflected in higher US mortgage rates. This will slow down the rebound in the real estate market.

Though it is highly likely this game of financial chicken will be avoided, the first half of next month could very well be a repeat of August 2011, with its heart stopping moments of brinkmanship, as the world's richest country teetered on the point of an unprecedented and unnecessary self-inflicted default.

The long term outlook for the American economy is by far the strongest of major economies, primarily due to its demography structure, entrepreneurial population and access to endless cheap energy and food supplies.

Needless to say Obama and Congress should put aside politician point scoring on this vital issue and increase the debt ceiling - while also agreeing a credible long term solution to curtail public spending.

Unfortunately the possibility of this looks remote.

No doubt a last ditch debt ceiling solution will be found in Washington by the end of October. Hopefully it won't derail the US economy recovery.

The world economy is depending on it.