What would happen if the US could no longer service its debt.
The time bomb is ticking – and nobody knows what will happen when the time is up. In the United States, the government and opposition are arguing about raising the statutory ceiling for government debt. A crisis meeting between President Joe Biden and opposition leader Kevin McCarthy on Tuesday yielded no results. On the financial markets, a default by the USA on its debts is treated as a horror scenario. However, it is not clear whether in this case the world will plunge into a crisis or nothing will happen at all. After all, what kind of strange bankruptcy would that be caused not by the creditors but by the debtor himself?
According to current legislation, the US government may not incur debts of more than $31.4 trillion. “This limit is a political construct without any fundamental economic sense,” explains the British magazine “Economist”. According to US Treasury Secretary Janet Yellen, this figure has now reached $31.4 trillion, and the money could run out as early as June 1st. Then Washington would have to shut down agencies — which has happened in the past — or suspend servicing its debt — which has never happened before.
The conversation between Biden and McCarthy on Tuesday did not bring any rapprochement in the dispute: the opposition is demanding drastic savings in order to agree to raising the debt ceiling – not even all Republican MPs are convinced that this makes sense. The ruling Democrats do not want to link budget negotiations to the debt ceiling. “I haven’t seen any new movement,” McCarthy said after the meeting. And Biden said there’s been “a lot of fuss and play and it’s going to continue for a while.”
Somehow, the financial markets assume that both sides will come to an agreement, just like in the past. If not, then it is indeed possible that the US government will be forced to suspend servicing its debt – because like all other developed countries, the US is servicing its debt by borrowing new ones. “A default would undermine confidence in the world’s most important financial system,” warns The Economist. And since the global financial system is based on the dollar and US Treasuries as safe havens, the turmoil would not be confined to the US. Nobody knows at the moment whether there will be a storm or just a gentle breeze. Because the USA is not a debtor like all the others and their default would be a novelty.
National bankruptcies usually hit countries in the Global South. They borrow foreign exchange, for example US dollars, on the global financial markets and service their debts by earning dollars through exports or taking out new dollar loans.
When times get bad, interest rates rise and new loans gradually become unaffordable. If there is an economic crisis, a country loses its creditworthiness, it does not receive any new loans, it cannot service its debts on time – defaults occur. As a result, the country asks the International Monetary Fund (IMF) for new loans and thus initiates its stabilization – and its recovery as a debtor.
The US case is very different. A sovereign default is usually preceded by a refusal by creditors to lend a country more. A default by the US, on the other hand, would probably be the first in history where it is the debtor himself who refuses to borrow – because he is forced to do so by his own legal ceiling.
What’s more, the dollars that the US needs to service its debts don’t have to be earned or borrowed from the financial markets. They can produce them themselves, after all the dollar is their currency. In theory, the US Federal Reserve could transfer any amount to the government by buying its bonds. Help from the IMF would be bizarre, after all, the fund’s financial power is essentially based on US loan commitments. Should the USA fall into disrepute on the financial markets, the basis of the world financial system itself would be shaken – no “bailout loan” in the world could bring stability again.
But this test is unlikely to happen. For both the US government and the opposition know that US global power rests on US creditworthiness.
The independent Congressional Budget Office predicts that if the current trend continues, the US debt ratio will double from the current 117 percent of economic output to 250 percent by the middle of the century. Further disputes over the debt ceiling are thus programmed.
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