What would it mean for the global economy if the United States defaulted on its debt?

WASHINGTON – If the debt crisis gripping Washington eventually sends the United States into recession, the US economy will not collapse on its own.

The fallout from a first federal debt default would soon reverberate around the world. Orders for Chinese factories that sell electronics to the United States may dry up. Swiss investors who own US Treasurys will suffer losses. Sri Lankan companies can no longer use dollars as an alternative to their elusive currency.

“No corner of the global economy will be spared” if the US government falters and the crisis is not quickly resolved, said Mark Zandi, chief economist at Moody’s Analytics.

Zandi and two colleagues at Moody’s concluded that even if the debt limit were breached for as little as a week, the US economy would weaken so much, so quickly, that it would wipe out nearly 1.5 million jobs.

In their analysis, Zandi and his colleagues found that if government defaults continue for much longer — well into the summer — the consequences will be very dire: U.S. economic growth will decline, 7.8 million American jobs will disappear, and borrowing rates will rise. The unemployment rate will rise from 3.4% to 8% and a stock market crash will wipe out $10 trillion of family wealth.

US debt, long viewed as very safe

Fueling the anxiety is the fact that so much financial activity hinges on confidence that America will always pay its financial obligations. Its debt, long seen as a very safe asset, is the foundation of global trade, built on decades of trust in the United States. A default could crash the $24 trillion Treasury debt market, freezing financial markets and sparking an international crisis.

“A debt default would be a catastrophic event, with unpredictable but potentially dramatic ramifications for US and global financial markets,” said Eswar Prasad, professor of trade policy at Cornell University and senior fellow at the Brookings Institution.

In the past, American political leaders have generally been able to step back from the brink and raise the debt limit before it is too late. Congress has raised, revised or extended the borrowing cap 78 times since 1960, most recently in 2021.

However, the problem worsened. Partisan divisions have widened in Congress while the debt has increased after years of high spending and deep tax cuts. Treasury Secretary Janet Yellen has warned that the government could default as soon as June 1 if lawmakers do not raise or suspend the ceiling.

shockwaves through the system

said Maurice Obstfeld, senior fellow at the Peterson Institute for International Economics and former chief economist at the International Monetary Fund.

Treasury bills 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.

Because of their perceived safety, U.S. government debt—Treasury bills and bonds and notes—carry a risk weight of zero in international banking regulations. Foreign governments and private investors hold approximately $7.6 trillion in debt – roughly 31% of the treasury bonds in the financial markets.

Since the dollar’s dominance has made it the de facto world currency since World War II, it is relatively easy for the United States to borrow and finance a growing pile of government debt.

But high demand for the dollar also tends to make it more valuable than other currencies, and that imposes a cost: A strong dollar makes American goods more expensive relative to their foreign competitors, leaving American exporters at a competitive disadvantage. This is one of the reasons why the United States has run a trade deficit every year since 1975.

Central bank stocks of dollars

Of all the foreign exchange reserves held by the central banks of the world, the US dollar accounts for 58%. No. 2 Euro: 20%. The Chinese yuan makes up less than 3%, according to the International Monetary Fund.

Federal Reserve researchers estimated that from 1999 to 2019, 96% of trade in the Americas was billed in US dollars. This is how 74% of trade was in Asia. Elsewhere outside Europe, where the euro dominates, dollars accounted for 79% of trade.

America’s currency is so reliable that merchants in some unstable economies demand payment in dollars, rather than their own country’s currency. Take, for example, Sri Lanka, which was hit by inflation and the dizzying drop in the local currency. Earlier this year, shippers refused to release 1,000 containers of badly needed food unless it was paid in dollars. Shipments piled up at the docks in Colombo because importers could not get dollars to pay suppliers.

“Without (dollars), we can’t do any deal,” said Nihal Seneviratne, a spokesperson for the Basic Food Importers and Traders Association. When we import, we have to use hard currency – mostly US dollars. ”

Likewise, many shops and restaurants in Lebanon, where inflation has soared and the currency has plummeted, require payment in dollars. In 2000, Ecuador responded to an economic crisis by exchanging its currency, the sucre, for dollars—a process called “dollarization”—and it stuck with it.

Go to the investors

Even when a crisis arises in the United States, the dollar is always the preferred haven for investors. That’s what happened in late 2008, when the US real estate market crash toppled hundreds of banks and financial firms, including the once-mighty Lehman Brothers: The value of the dollar soared.

“Even though we were the problem — we are the United States — there was still a drive for quality,” said Clay Lowry, who oversees research at the Institute of International Finance, a banking trade group. “The dollar is king.”

If the US breaches the debt limit without resolving the dispute and the Treasury defaults on its payments, Zandi suggests the dollar will rise again, at least initially, “because of uncertainty and fear. Global investors will only know where they are going unless they always go when There will be a crisis and this in the United States.

But the treasury market is likely to be paralyzed. Investors may instead transfer funds to US money market funds or bonds of major US corporations. Ultimately, Zandi says, the growing uncertainty will depress the dollar and keep it down.

The government’s strategy in the event of a breach of the debt ceiling

In the debt ceiling crisis, Lowry, who was assistant secretary of the Treasury during the 2008 crisis, imagines that the United States will continue to make interest payments to bondholders. And it will try to pay its other liabilities — to contractors and retirees, for example — in order for those bills to become due and as funds become available.

For bills that were due on June 3, for example, the government might pay on June 5. A little relief will come around June 15th. This is when government revenue will flow as many taxpayers make their estimated tax payments for the second quarter.

The government is likely to be sued by those who haven’t been paid — “anyone living on Veterans Benefits or Social Security,” Lowry said. And rating agencies are likely to downgrade the US debt rating, even if the Treasury Department continues to pay interest to bondholders.

Although the dollar remains dominant globally, it has lost some of its gains in recent years as more banks, companies and investors have turned to the euro and, to a lesser extent, the Chinese yuan. Other countries tend to resent that fluctuations in the value of the dollar can hurt their currencies and economies.

A rising dollar can lead to crises abroad by withdrawing investment from other countries and raising the cost of repaying dollar-denominated loans. And the eagerness of the United States to use the influence of the dollar to impose financial sanctions on its competitors and adversaries is also uncomfortable by some other countries.

But so far, no clear alternatives have emerged. The euro lags far behind the dollar. Even more so does the Chinese Yuan. It has been hampered by Beijing’s refusal to allow its currency to circulate freely on global markets.

But the debt-ceiling drama is sure to heighten questions about the enormous financial power of the US and the dollar.

“The global economy is in a very fragile place right now,” said Obstfeld. So to throw a crisis into the mix about the creditworthiness of US obligations is incredibly irresponsible.”


Associated Press writer Bharata Malawarashi in Colombo, Sri Lanka, contributed to this report.

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