What it would mean for the global economy if the US defaults on its debt
WASHINGTON (AP):
IF THE debt crisis roiling Washington were eventually to send the United States crashing into recession, America’s economy would hardly sink alone.
The repercussions of a first-ever default on the federal debt would quickly reverberate around the world. Orders for Chinese factories that sell electronics to the United States could dry up. Swiss investors who own US Treasurys would suffer losses. Sri Lankan companies could no longer deploy dollars as an alternative to their own dodgy currency.
“No corner of the global economy will be spared” if the US government defaulted and the crisis weren’t resolved quickly, said Mark Zandi, chief economist at Moody’s Analytics.
Zandi and two colleagues at Moody’s have concluded that even if the debt limit were breached for no more than a week, the US economy would weaken so much, so fast, as to wipe out roughly 1.5 million jobs.
And if a government default were to last much longer — well into the summer — the consequences would be far more dire, Zandi and his colleagues found in their analysis: US economic growth would sink, 7.8 million American jobs would vanish, borrowing rates would jump, the unemployment rate would soar from the current 3.4 per cent to eight per cent, and a stock market plunge would erase US$10 trillion in household wealth.
Of course, it might not come to that. The White House and House Republicans, seeking a breakthrough, concluded a round of debt-limit negotiations o Sunday, with plans to resume talks on Monday. The Republicans have threatened to let the government default on its debts by refusing to raise the statutory limit on what it can borrow unless President Joe Biden and the Democrats accept sharp spending cuts and other concessions.
US DEBT, LONG VIEWED AS ULTRA-SAFE
Feeding the anxiety is the fact that so much financial activity hinges on confidence that America will always pay its financial obligations. Its debt, long viewed as an ultra-safe asset, is a foundation of global commerce, built on decades of trust in the United States. A default could shatter the US $24trillion market for Treasury debt, cause financial markets to freeze up, and ignite an international crisis.
“A debt default would be a cataclysmic event, with an unpredictable but probably dramatic fallout on US and global financial markets,” said Eswar Prasad, professor of trade policy at Cornell University and senior fellow at the Brookings Institution.
The threat has emerged just as the world economy is contending with a panoply of threats — from surging inflation and interest rates to the ongoing repercussions of Russia’s invasion of Ukraine to the tightening grip of authoritarian regimes. On top of all that, many countries have grown skeptical of America’s outsize role in global finance.
In the past, American political leaders generally managed to step
away from the brink and raise the debt limit before it was too late. Congress has raised, revised or extended the borrowing cap 78 times since 1960, most recently in 2021.
Yet the problem has worsened. Partisan divisions in Congress have widened, while the debt has grown after years of rising spending and deep tax cuts. Treasury Secretary Janet Yellen has warned that the government could default as soon as June 1 if lawmakers don’t raise or suspend the ceiling.
SHOCK WAVES THROUGH THE SYSTEM
“If the trustworthiness of (Treasurys) would become impaired for any reason, it would send shock waves through the system ... and have immense consequences for global growth,” said Maurice Obstfeld, senior fellow at the Peterson Institute for International Economics and former chief economist at the International Monetary Fund.
Treasurys are widely used as collateral for loans, as a buffer against bank losses, as a haven in times of high uncertainty, and as a place for central banks to park foreign exchange reserves.
Given their perceived safety, the US government’s debts — Treasury bills, bonds and notes — carry a risk weighting of zero in international bank regulations. Foreign governments and private investors hold nearly US$7.6 trillion of the debt — roughly 31 per cent of the Treasurys in financial markets.
Because the dollar’s dominance has made it the de facto global currency since World War II, it’s relatively easy for the United States to borrow and finance an evergrowing pile of government debt.
But high demand for dollars also tends to make them more valuable than other currencies, and that imposes a cost: A strong dollar makes American goods pricier relative to their foreign rivals, leaving US exporters at a competitive disadvantage. That’s one reason why the United States has run trade deficits every year since 1975.