US Default would destabilize Global Economy

A US default could destabilize the global economy with a series of domino effects, in particular across financial markets, which would cause a systemic financial crisis.

Treasury Secretary Janet Yellen informed US lawmakers that the government could run out of cash to pay its bills as early as June 1, 2023.

The USA hit that limit – $31.4 trillion – on January 19, 2023, but the Treasury has undertaken measures to buy time for lawmakers to raise the debt ceiling. If the borrowing limit isn’t increased, the US could default, Yellen warned.

She also depicted some of the gloomy consequences of the potential crisis that could include severe hardship to American families, upended US global leadership, and damage to the nation’s security interests. Is Yellen’s alarm justified?

If the USA fails to pay its debts, there will be a systemic financial crisis, particularly because the US dollar is a so-called key currency in the global economy.

A former US Treasury Secretary told Europe that ‘the US dollar is our currency, but your problem’, since the 1944 Bretton Woods agreements put this currency at the core of the international monetary regime.

Hence, any US default will destabilize the global economy with a series of domino effects, in particular across financial markets that would induce a dramatic global crisis, with a series of negative consequences for several banks and non-bank financial institutions, small and medium-sized firms as well as transnational corporations across the world.

The Federal Reserve can refinance the US federal government without any budget constraint for it, since it can issue as much money as it will in this regard, according to the economist.

Indeed, even the US Constitution makes debt default impossible, by stating that the validity of the public debt of the United States, authorized by law (…) shall not be questioned.

The forthcoming meeting between US President Joe Biden and top congressional leaders should translate into some sort of bipartisan compromise to avoid further troubles.

In the absence of such an agreement, to be sure, there will be a systemic financial crisis originating again in the USA, with a series of negative consequences both for the USA and the connected global economy.

Meanwhile, the US national debt has grown by roughly $25 trillion since 1993 and is continuing to go up. Interest payments on the national debt were $475 billion in fiscal year 2022 and are projected to grow by another 35% in 2023.

According to some estimates, the US debt-to-GDP ratio amounts to around 133% making it the 12th most indebted country in the world, and the fourth most indebted economy among developed countries. Meanwhile, earlier this year.

Some House Democrats proposed legislation that would eliminate the debt ceiling all together to allow unlimited government borrowing. How sustainable is it for America to keep increasing its national debt?

The sustainability of US public debt depends on two issues.

On the one hand, this has to do with the object of increasing public debt: if this occurs for investment purposes – particularly as regards healthcare, public transports, education and a properly-defined ecological transition.

It will increase produced output as well as social cohesion and the employment level, which will allow the US federal government to reimburse this debt eventually.

On the other hand, much depends on the US monetary policy stance, to wit, on the evolution of the policy rates of interest decided by the Federal Reserve, which in both the short and long run affect all market rates of interest, hence also the interest rate the US government must pay to its bondholders.

If this rate increases over time, as one can note in this period, then a larger share of public expenditures is dedicated to such a debt service, thereby reducing the amount of tax income the government can really use to finance its provision of public goods and services such as healthcare and education.

If the Federal Open Market Committee (FOMC) decides to raise interest rates again in the USA, it will further aggravate the situation, first across the financial sector, then also in the economy as a whole – both in the USA and across the global economy.

Sputnik / ABC Flash Point News 2023.