The ongoing debt crisis in Washington could push the United States into a recession. This would profoundly affect America’s economy and the entire global economic landscape.
Should the U.S. government default on its debt for the first time, the impacts would reverberate globally. Chinese factories reliant on selling electronics to the U.S. might see orders dwindle. Swiss investors holding U.S. Treasurys could face significant losses. In Sri Lanka, businesses might need help to use U.S. dollars as a safe alternative to their unstable currency.
Chief economist at Moody’s Analytics, Mark Zandi, believes that every part of the global economy would remain untouched if the U.S. were to default on its debt and the situation not swiftly resolved. Zandi and his team at Moody’s have projected that if the debt limit was breached for even a week, it could severely destabilize the U.S. economy, resulting in a loss of approximately 1.5 million jobs.
Should a government default endure much longer, potentially into the summer, the fallout would be far graver. Moody’s analysis points to plummeting U.S. economic growth, the loss of around 7.8 million American jobs, soaring borrowing rates and unemployment, and a stock market crash that could wipe out $10 trillion in household wealth.
Although such a bleak scenario may not materialize, the risk remains. The White House and House Republicans have recently concluded a round of debt-limit talks, with further discussions scheduled. Republicans have threatened to allow a government default by resisting a rise in the borrowing limit unless President Joe Biden and Democrats agree to drastic spending cuts and other concessions.
Given the global reliance on the American economy, the prospect of a U.S. default fuels anxiety. The U.S.’s long-standing reputation for meeting its financial obligations has made its debut a pillar of international commerce, underpinned by decades of trust. A default could disrupt the $24 trillion market for Treasury debt, bring financial markets to a standstill, and spark a global crisis.
With the global economy already dealing with various threats, including rising inflation, interest rates, Russia’s invasion of Ukraine, and the tightening grip of authoritarian regimes, the risk of U.S. default adds further pressure. Trust in America’s influential role in global finance has been eroding, further complicating the situation.
Historically, American political leaders have managed to avoid such a crisis by raising the debt limit in time. The debt ceiling has been submitted, revised, or extended 78 times since 1960, the latest in 2021. However, the issue has been exacerbated recently, with partisan divisions in Congress deepening and the national debt swelling due to increased spending and substantial tax cuts. Treasury Secretary Janet Yellen has warned of a possible default as early as June 1 unless the debt ceiling is raised or suspended.
The question of trust in U.S. Treasury securities holds immense consequences for global growth. These are used for various financial operations, from collateral for loans to a buffer against bank losses to a reserve for central banks. Given their relative safety, the U.S. government’s debts — Treasury bills, bonds, and notes — have zero risk weighting in international bank regulations. Foreign governments and private investors hold nearly $7.6 trillion of the debt, accounting for roughly 31% of the Treasurys in financial markets.
The dollar’s preeminence has enabled the U.S. to finance a growing stack of government debt easily. However, a strong dollar places American goods at a comparative disadvantage in international markets, contributing to continuous trade deficits since 1975.
In the foreign exchange reserves held by global central banks, U.S. dollars account for 58%, the euro is at 20%, and China’s yuan is less than 3%, per the IMF. Unstable economies often demand payment in U.S. dollars due to its reliability.
If a default were to occur, the U.S. would likely continue to make interest payments to bondholders while trying to meet other obligations as funds become available. Nonetheless, the government would likely face lawsuits from unpaid parties and a potential downgrade of U.S. debt by rating agencies.
Despite its global dominance, the dollar has recently lost some appeal, with more entities opting for the euro or China’s yuan. Yet, no superior alternatives have emerged due to the significant financial influence of the U.S. and the dollar.
The current debt ceiling dispute undoubtedly amplifies concerns about America’s financial power. As a senior fellow at the Peterson Institute for International Economics, Maurice Obstfeld concludes, “The global economy is in a pretty fragile place right now, so throwing into that mix a crisis over the creditworthiness of U.S. obligations is incredibly irresponsible.”
The potential of a U.S. debt default is a troubling proposition that could unsettle the delicate equilibrium of the global economy. With global financial systems highly intertwined with the U.S. economy, the consequences of a default would undoubtedly have far-reaching effects. Given the increased fiscal and geopolitical pressures that the world is grappling with, it is paramount that this financial impasse be resolved swiftly and responsibly, reinforcing trust in the U.S. economy and the global economic systems at large.
