The United States’ national debt has been a topic of concern for many years, with the government continuously raising the debt ceiling to accommodate its financial obligations. However, if the US were to default on its debt, the consequences would have a significant impact not only on the American economy but also on the global economy. In this article, we will discuss the potential outcomes of a US debt default and how it could affect countries worldwide.
US Debt: A Pillar of Global Commerce
The US government’s debt, long viewed as an ultra-safe asset, is a foundation of global commerce, built on decades of trust in the United States. A default could shatter the $24 trillion market for Treasury debt, cause financial markets to freeze up, and ignite an international crisis.
“A debt default would be a cataclysmic event, with an unpredictable but probably dramatic fallout on US and global financial markets,” said Eswar Prasad, professor of trade policy at Cornell University and senior fellow at the Brookings Institution.
The threat has emerged just as the world economy is contending with various threats – from surging inflation and interest rates to the ongoing repercussions of Russia’s invasion of Ukraine and the tightening grip of authoritarian regimes. On top of all that, many countries have grown skeptical of America’s outsized role in global finance.
The Role of US Treasurys in Global Finance
US Treasury bonds 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. Given their perceived safety, the US government’s debts carry a risk weighting of zero in international bank regulations.
Foreign governments and private investors hold nearly $7.6 trillion of the debt – roughly 31 percent of the Treasurys in financial markets. The stability and trust in US debt have made it a cornerstone of global finance.
Potential Consequences of a US Debt Default
If the US were to default on its debt, the repercussions would be felt worldwide. Here are some possible outcomes:
Impact on the US Economy
A US debt default could have severe consequences for the American economy. According to an analysis by Moody’s Analytics, even if the debt limit were breached for no more than a week, the US economy would weaken so much, so fast, as to wipe out roughly 1.5 million jobs.
If a government default were to last much longer, the consequences would be far more dire: US economic growth would sink, 7.8 million American jobs would vanish, borrowing rates would jump, the unemployment rate would soar, and a stock-market plunge would erase trillions in household wealth.
Effects on Global Markets
A US debt default would send shockwaves through global markets, potentially causing them to freeze up and triggering a worldwide financial crisis. Investors would likely lose confidence in US debt, which could lead to a collapse in the Treasury market and a massive sell-off of US assets.
Countries that are heavily invested in US debt would suffer significant losses, as the value of their holdings would plummet. This could lead to a domino effect, as these countries might need to sell off other assets to cover their losses, further destabilizing global markets.
The Dollar’s Dominance at Risk
The US dollar has been the dominant global currency since World War II, with central banks around the world holding large amounts of dollar reserves. If the US were to default on its debt, the value of the dollar could decline, potentially causing a shift away from the dollar as the world’s primary reserve currency.
This could lead to increased demand for alternative currencies, such as the euro or the Chinese yuan, which could further weaken the dollar’s position in global finance.
Impact on International Trade
A US debt default could also have significant implications for international trade. The dollar is the primary currency used in international trade transactions. If the value of the dollar were to decline significantly, it could disrupt global supply chains and lead to increased costs for businesses and consumers.
Moreover, a US debt default could lead to a decline in demand for American goods, as a weaker dollar would make US exports more expensive for foreign buyers. This could further hurt the US economy, as well as the economies of countries that rely heavily on trade with the United States.
Effects on Developing Countries
Developing countries could be particularly vulnerable to the consequences of a US debt default. Many developing nations hold large amounts of US debt and rely heavily on dollar-denominated financing. A default could lead to a decline in the value of their dollar reserves, making it more difficult for these countries to service their debt and finance their development projects.
Furthermore, a US debt default could lead to a slowdown in global trade, which would hurt export-dependent developing countries. A decline in demand for their goods could lead to lower economic growth, higher unemployment, and increased poverty in these nations.
Possible Strategies to Avoid a US Debt Default
In the event of a debt-ceiling crisis, the US government could explore several strategies to avoid a default on its debt. These include:
Prioritizing Interest Payments
The US government could prioritize interest payments to bondholders, ensuring that it meets its debt obligations even if it is unable to pay other bills. While this would help to maintain the creditworthiness of US debt, it could lead to lawsuits from those who are not getting paid, such as contractors and retirees.
Raising or Suspending the Debt Ceiling
Congress has raised, revised, or extended the borrowing cap 78 times since 1960, most recently in 2021. If lawmakers were to raise or suspend the debt ceiling once again, it would allow the US government to continue borrowing and meeting its financial obligations.
Using the 14th Amendment
The 14th Amendment to the US Constitution states that the public debt of the United States, authorized by law, shall not be questioned. Some argue that this provision could be used to bypass the debt ceiling and allow the government to continue borrowing. However, using the 14th Amendment in this way is a controversial and untested approach, with potential legal challenges and political consequences.
A US debt default would have far-reaching consequences for the global economy, affecting countries worldwide and potentially triggering a financial crisis. As the world grapples with various economic challenges, the prospect of a US debt default adds another layer of uncertainty to an already fragile global economic landscape.
It is crucial for policymakers in the United States to work together to address the debt ceiling issue and find a solution that ensures the continued stability of the US and global economies. The consequences of failing to do so could be catastrophic, with lasting effects for years to come.