- By Dearbail Jordan
- Business Correspondent, BBC News
The United States government is currently involved in what could be one of the most expensive games of chicken in history.
If Democrats and Republicans do not agree to let the US borrow more – or raise the debt ceiling in their language – the world’s largest economy will default on its $31.4tn (£25tn) debt.
They have to come to an agreement by the fateful “X-date” of June 1st.
If they don’t, councilor Jeremy Hunt warned the impact would be “extremely devastating”.
So what does that mean for the economy — and for you?
First things first: Not all the experts the BBC spoke to believe the US will default on its debt.
However, if that were to happen, “it would make the global financial crisis look like a tea party,” says Simon French, chief economist at investment bank Panmure Gordon, referring to the impending collapse of the global banking industry in 2008.
If the United States does not raise its debt ceiling, it will not be able to borrow any more money — and it will soon run out of money to pay off public benefits and other liabilities.
“It will stop disbursing welfare and support payments to people, which will hurt their ability to spend and pay their bills,” says Ross Mould, chief investment officer at AJ Bell. So it will hurt the economy.”
Economist Mohamed El-Erian, chair of Queen’s College at the University of Cambridge, says the default “has the potential to push the US into recession”.
This will have a significant impact on the rest of the world, including the United Kingdom, which considers the United States a major trading partner.
“The US is one of the biggest trading partners in the world,” he says. “It will buy less products than the rest of the world.”
El-Erian does not believe a recession in the US will lead to an economic slowdown in Britain, but Mr French is “100%” sure it will.
In addition to hurting trade, French says defaults in the US will cause the cost of mortgages in the UK to rise, leading to higher unemployment in the UK.
“It would be very disastrous,” he says.
Why are problems in the US making mortgage more expensive in the UK?
When the government wants to borrow money, it issues a bond or legal bond. In the United States, it is called a Treasury note and in the United Kingdom it is called a gold bond. The investor gets interest from the government if he buys treasury bonds or gold bonds.
If the US government doesn’t pay its debt or even pay interest, “investors will look at this and say ‘Well, if the US can default, what’s to stop the UK from defaulting?'” French says.
Investors can then demand a higher interest rate to buy UK government debt.
“Interest rates on debt – whether mortgage debt or public debt – derive their strength from how clearly the risks are perceived [a US default] It would be an enormously risky event, so all the debt would become more expensive overnight.”
Prices could go up
The US dollar is the world’s reserve currency.
What this means is a long list of important commodities such as oil, which is used to make gasoline, and wheat, which is ground into flour to make bread, is priced in dollars.
In the event of a US government default, the value of the dollar is expected to drop sharply.
It sounds like that might be good news for people outside the US, but it could mean that commodity investors “don’t know how to price things,” French says.
“What you have with a US default,” he said, “is the sudden panic of investors as they wonder, Is Japan next? Is the UK next? Germany next?”
“Suddenly we have to re-price everything, and in economic terms it’s a risk premium. You get a risk premium added to the prices, so the bread becomes more expensive.”
If food and fuel become more expensive, it will increase the cost of living for millions of people.
Your pension could suffer
According to Mold, the United States accounts for 60% of the value of global stock markets.
“So it’s likely that people will be dealing with US stocks in their pensions whether they know it or not,” he said.
Equity markets are likely to react badly to a US default.
But it’s not all bad news.
In 2011, Democrats and Republicans were deadlocked over the debt ceiling until hours before a potential default.
US stock markets fell. But the panic did not last long and stocks recovered from the sharp decline.
Mr Mold thinks that will be the case this time.
Although people drawing pensions now could be affected, he says, “if you draw it somewhere down the line, you have time to make up that shortfall.”
#debt #default #unleash #global #chaos #BBC #News