If the United States defaults on its debt, how will the world economy be affected? cbc news (2023)

If the debt crisis in Washington eventually pushes the US into recession, it will be difficult for the US economy to sink on its own.

The fallout from the first-ever federal debt default will soon reverberate around the world.

If the U.S. government defaults and the crisis is not resolved quickly, "no corner of the global economy will be spared," said Mark Zandi, chief economist at Moody's Analytics.

Zandi and two Moody's colleagues concluded that even if the debt ceiling was not exceeded for more than a week, the U.S. economy would weaken rapidly, resulting in the disappearance of about 1.5 million jobs.

In their analysis, Zandi and his colleagues found that if the state had defaulted for longer -- all the way into the summer -- the consequences would have been far worse: U.S. economic growth would have declined, 7.8 million U.S. jobs would have disappeared, interest rates would have will rise, the US unemployment rate will rise to 8% from the current 3.4%, and the decline in the stock market will wipe out $10 trillion in household wealth.

Of course it might not happen.

The White House and House Republicans, seeking a breakthrough, continue to negotiate the debt ceiling. U.S. President Joe Biden met with House Speaker Kevin McCarthy on Monday, and both sides described their talks as "productive."

Still, Republicans have threatened to refuse to raise the statutory amount the government can borrow unless Biden and Democrats agree to deep budget cuts and other concessions. cap, thereby causing the government to default.

Potential "catalyst"

So much financial activity around the world depends on confidence that the United States will always meet its financial obligations. Its debt has long been considered a highly safe asset, the foundation of world trade built on decades of trust in the United States. A default could destroy the $24 trillion U.S. government debt market, freeze financial markets and trigger an international crisis.

“A default would be a catastrophic event with unpredictable but potentially severe consequences for 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.

The threat has emerged as the global economy grapples with a wide range of threats -- from rising inflation and interest rates to the lingering fallout from Russia's invasion of Ukraine to authoritarian regimes tightening their grip.

In addition, many countries are skeptical about the important role of the United States in global finance.

In the past, U.S. political leaders have usually tried to back off and raise the debt ceiling before it was too late.

Since 1960, Congress has raised, modified or extended the debt ceiling 78 times, most recently in 2021.

See | Negotiations continue:

So what's different this time?

The problem just got worse. The partisan divide in Congress has widened, while the debt has risen after years of increased spending and sweeping tax cuts. U.S. Treasury Secretary Janet Yellen has warned that the government could default as early as June 1 if lawmakers fail to raise or suspend the cap.

Maurice Oberstfeld, a senior fellow and former principal fellow at the Peterson Institute for International Economics, said: "If [the Treasury Department's] credibility deteriorates for any reason, there will be shock waves through the entire system ... and have a large impact on global growth," said an economist at the International Monetary Fund.

Treasuries are widely used as collateral for loans, a buffer against losses for banks, a safe haven in times of high uncertainty, and a place for central banks to store foreign exchange reserves.

Given that they are considered safe, U.S. government debt -- government bonds, corporate bonds and notes -- carries a risk weight of zero under international banking rules. Foreign governments and private investors hold nearly $7.6 trillion in debt—roughly 31 percent of government bonds in financial markets.

Since the U.S. dollar has been the de facto world currency since World War II, it is relatively easy for the U.S. to borrow and finance its growing national debt.

want dollars

But high demand for dollars also often makes the greenback more valuable than other currencies, and that comes at a cost: A strong dollar makes U.S. goods more expensive relative to their foreign rivals, putting U.S. exporters at a competitive disadvantage. This is one of the reasons why the US has run a trade deficit every year since 1975.

The U.S. dollar accounts for 58 percent of all foreign exchange reserves held by central banks around the world. No. 2 is 20% of the euro. The yuan accounts for less than 3 percent, according to the International Monetary Fund.

Fed researchers calculated that from 1999 to 2019, 96% of U.S. trade was denominated in dollars. The same is true for 74% of trade in Asia. Elsewhere outside Europe, where the euro dominates, the dollar accounts for 79% of trade.

The U.S. dollar is so reliable that some merchants in unstable economies demand payments in U.S. dollars rather than their national currency.

Take Sri Lanka, for example, which has suffered from inflation and a sharp devaluation of its currency. Earlier this year, shippers refused to release 1,000 containers of much-needed food unless paid for in U.S. dollars. Cargo is piling up at the port of Colombo as importers are unable to raise funds to pay suppliers.

“Without [dollars], we cannot do any transactions,” said Nihal Seneviratne, spokesman for the Basic Food Importers and Traders Association. "When we import, we have to use hard currency -- usually dollars."

Likewise, in Lebanon, where inflation has soared and the currency has devalued, many shops and restaurants require payment in U.S. dollars. In 2000, Ecuador responded to the economic crisis by replacing its currency, the sucre, with dollars — a process known as “dollarization” — and it has continued.

If the U.S. breaches its debt ceiling without resolving the dispute and the Treasury defaults on payments, Zandi said the dollar would rise, at least initially, "because of uncertainty and fear. Global investors simply don't know where they have to go ’ , except where they always go in times of crisis, which is the United States. "

But financial markets could be paralyzed. Investors can move funds into U.S. money market funds or bonds of top U.S. companies. Ultimately, growing doubts can cause the dollar to weaken and stay the same, Zandi said.

Who will — and won’t — get paid

Amid the debt-ceiling crisis, Lowery, who was assistant secretary of the Treasury during the 2008 crisis, proposed that the U.S. keep paying interest to bondholders. And it will try to pay its other obligations -- for example, obligations to contractors and retirees -- in the order in which those bills are due and funded.

For example, for a bill due on June 3, the government may want to pay it on June 5. There will be a slight relief around June 15th. That's when government revenues will start to pick up, as many taxpayers will pay estimated taxes in the second quarter.

The government will likely be sued by those who aren't getting paid — "anyone living on VA benefits or Social Security," Lowery said. Ratings agencies could cut U.S. debt even as the Treasury continues to pay interest to bondholders.

The debt ceiling drama will undoubtedly raise questions about the enormous economic power of the US and the dollar.

"The global economy is in a pretty fragile state right now," Obstfeld said. “So it would be extremely irresponsible to include the credit crisis of US debt.”