WASHINGTON (AP) – Even if the debt crisis roiling Washington ultimately sends the United States into recession, it is unlikely that the U.S. economy will sink alone.
The effects of the first ever federal debt default will soon ripple around the world. Orders from Chinese factories that sell electronics to the U.S. could dry up. Swiss investors holding US Treasuries will suffer losses. Sri Lankan companies can no longer introduce the dollar as an alternative to their country’s risky currency.
Mark Zandy, chief economist at Moody’s Analytics, said “no corner of the global economy will be saved” if the U.S. government defaults and the crisis isn’t resolved quickly.
Mr. Zandy and two colleagues at Moody’s concluded that even if the debt limit were breached within a week, the U.S. economy would weaken so quickly that about 1.5 million jobs would disappear.
And if the government’s debt defaults continue well into the summer, the consequences would be even more dire, Zandy and his colleagues said. found in their analysis: U.S. economic growth slows, 7.8 million American jobs disappear, borrowing rates skyrocket, unemployment jumps to 8% from current 3.4%, stock market crash leads to $10 trillion Household assets will disappear.
Of course, that may not be the case. The White House and House Republicans sought a way out, ending the round of negotiations on the debt ceiling on Sunday.plans to resume talks on Monday. Republicans have refused to raise the statutory borrowing limit and threatened to allow the government to default unless President Joe Biden and Democrats accept significant spending cuts and other concessions.
Fueling the anxiety is the fact that much financial activity relies on the belief that the United States will pay its financial obligations. Long considered a super-safe asset, its debt is the foundation of global trade built on decades of trust in the United States. A default could collapse the $24 trillion Treasury bond market, freeze financial markets and trigger a global crisis.
“A default would be a catastrophe, with an unpredictable but arguably dramatic impact on U.S. and global financial markets,” said Eswar Prasad, a professor of trade policy at Cornell University and a senior fellow at the Brookings Institution. Stated.
The threat comes at a time when the global economy is grappling with threats ranging from skyrocketing inflation and interest rates, to the ongoing impact of Russia’s invasion of Ukraine, to the tightening grip of dictatorships. In addition, many countries are skeptical of America’s major role in global finance.
So far, US political leaders have usually been able to pull themselves out of the brink and raise the debt ceiling before it’s too late. Congress has raised, modified, or extended the borrowing limit 78 times since 1960, most recently in 2021.
But the problem is getting worse. Years of higher spending and drastic tax cuts have increased the debt, while increasing partisan divisions in Congress. Treasury Secretary Janet Yellen has warned that the government could default as early as June 1 if lawmakers don’t raise or stop the cap.
Maurice Obstfeld, senior fellow and former president of the Peterson Institute for International Economics, said: “If credibility (of U.S. Treasuries) is compromised for any reason, it will send shockwaves through the whole system and have a huge impact on global growth. It will have no impact,” he said. Economist at the International Monetary Fund.
The Treasury is widely used as collateral for loans, as a buffer against bank losses, as a safe haven when uncertainty is high, and as a place for central banks to store foreign exchange reserves.
Due to its perceived safety, US government debt (treasury bills, bonds, and banknotes) is zero risk-weighted under international banking regulations. Foreign governments and private investors hold nearly $7.6 trillion in debt, about 31% of US Treasuries in financial markets.
After World War II, the dollar’s dominance made it the de facto global currency, making it relatively easy for the United States to borrow or lend its ever-growing mountain of government debt.
However, high demand for the dollar tends to make the dollar more valuable than other currencies, which imposes costs. A strong dollar makes U.S. goods more expensive than their foreign rivals, putting U.S. exporters at a competitive disadvantage. This is one reason the US has been running a trade deficit every year since her 1975.
The US dollar accounts for 58% of the foreign reserves held by central banks around the world. Second place is the euro: 20%. According to the IMF, the Chinese yuan accounts for less than 3%.
Fed researchers calculated that from 1999 to 2019, 96% of trade in the Americas was billed in US dollars. So did 74% of Asian trade. Outside Europe, where the euro dominates, the dollar accounted for 79% of trade.
America’s currency is so reliable that in some volatile economies merchants demand payments in dollars rather than in their own currency. Consider Sri Lanka, which has been hit hard by inflation and a dizzying depreciation of its local currency. Earlier this year, shippers refused to release 1,000 containers of urgently needed food unless they paid in dollars. The cargo piled up on Colombo’s docks because the importers were unable to raise dollars to pay their suppliers.
“Without (dollars), you can’t do any trade,” said Nihal Seneviratne, a spokeswoman for the Essential Food Import Traders Association. “When importing, you should use foreign currency, mainly US dollars.”
Similarly, many shops and restaurants in Lebanon, where inflation is soaring and the currency is collapsing, require payment in dollars. In 2000, Ecuador responded to the economic crisis by replacing its currency, sucre, with the dollar, continuing a process known as “dollarization.”
The dollar will always be the go-to place for investors, even when the crisis hits the United States. That’s what happened in late 2008, when the collapse of the US real estate market brought down hundreds of banks and financial companies, including the once mighty Lehman Brothers. The value of the dollar soared.
“Even though the problem is the United States, there was still a flight to quality,” said Clay Rowley, who oversees research at the Institute of International Finance, a banking industry body. “The dollar is king.”
If the U.S. breaks the debt ceiling without resolving the dispute and the Treasury fails to pay, at least initially, “the dollar will rise again because of uncertainty and fear,” Zandi suggested. ing. Global investors will not know where to go other than the place they always go when a crisis strikes: the United States. “
But the Treasury market will probably be paralyzed. Investors may instead move their money into U.S. money market funds and corporate bonds of top U.S. companies. Ultimately, Zandi said, growing skepticism will reduce the value of the dollar and devalue the dollar.
Lowry, who was assistant secretary of the treasury during the 2008 crisis, imagines the US will continue to pay interest to bondholders in a debt ceiling crisis. And other obligations, such as payments to contractors and retirees, will be paid as they become due and funds become available.
For example, an invoice due on June 3rd may be paid by the government on June 5th. There will be a slight easing around June 15th. By that time, government revenue will flow in as many taxpayers make their second-quarter estimated payments.
Lowry said the government would likely face lawsuits from people who don’t get paid — “people who live on Veteran’s Benefits or Social Security.” And even if the Treasury continues to pay interest to bondholders, rating agencies are likely to downgrade U.S. government bonds.
While the dollar still dominates globally, it has lost some ground in recent years as more banks, companies and investors turned to the euro and, to a lesser extent, the Chinese yuan. Other countries tend to resent the impact that fluctuations in the value of the dollar have on their currencies and economies.
A rising dollar could trigger a crisis abroad by drawing investment from other countries and raising the cost of repaying dollar-denominated loans. The U.S. willingness to use the dollar’s clout to impose financial sanctions on rivals and adversaries is also alarming in some other countries.
However, so far no clear alternative has been found. The euro lags far behind the dollar. Even more so for the Chinese yuan. It has been hampered by the Chinese government’s refusal to trade its currency freely in global markets.
But the debt ceiling drama is sure to raise questions about the enormous financial power of the US and the dollar.
“The global economy is in a pretty fragile situation right now,” Obstfeld said. “It is therefore incredibly irresponsible to throw the crisis over the creditworthiness of US debt into this context.”
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Associated Press reporter Bharata Malawarachi, who lives in Colombo, Sri Lanka, contributed to the report.
