A few hours ago the House of Representatives narrowly passed a bill to raise the US government’s debt ceiling, including significant spending cuts over the next decade. The bill passed by Republicans in the House aims to boost Washington’s borrowing capacity by $1.5 trillion, or until March 31, 2024, whichever comes first.
The bill is not expected to pass the Senate and President Joe Biden would veto it if it did. The current political maneuver of passing an economic bill that is unlikely to become law has put the United States in a dangerous position, risking a potential default on its loan payments.
The bill proposes to reduce spending to 2022 levels and restrict annual growth to 1%, eliminate certain renewable energy tax incentives, and increase work requirements for some anti-poverty initiatives.
However, the White House and congressional Democrats insist on a debt limit increase with no strings attached, and Biden would not sign off on such cuts.
The cost to insure against a US default is rising pic.twitter.com/bcHFm7WPka
— Cheddar Flow (@CheddarFlow) April 29, 2023
Failure of prompt action from Congress to pass a mutually acceptable debt ceiling increase bill for both Republicans and Democrats could result in the US government defaulting on its loans. The US Treasury Department could potentially face a situation where it is unable to pay its bills within a few weeks, which could have disastrous consequences.
In 2011, a similar situation resulted in a downgrade of the government’s credit rating, which caused borrowing costs to rise and inflicted significant losses on investors.
This article will examine the potential consequences of a US debt default, including its effects on the domestic economy, the international economy, and the stability of the global financial system.
What happens if the US defaults on its Debt
Higher Interest Rates and Borrowing Costs
If the United States can’t pay back its debts, it would be a big problem for the country’s economy and the global financial system. This would cause the interest rates to rise because investors would be worried about lending money to a government that cannot pay back its debts.
As a result, the cost of borrowing money would increase for everyone, like the government, companies, and regular people. This increase in borrowing costs would slow down the economy and could even lead to a recession.
Downgrading of the US government’s credit rating
If the US government defaults on its debt, it will damage its credit rating. This means investors who lend the US government money won’t be as confident about getting their money back, and they’ll charge higher interest rates to compensate for the risk. It’s like how a bank might charge someone with a bad credit score a higher interest rate on a loan than someone with a good credit score.
If the credit rating is downgraded, it will make it more expensive for the US government to borrow money in the future, which will worsen the country’s already significant financial problems. It’s like how someone with a low credit score might have to pay more to borrow money, and that makes it harder to pay off their debts.
U.S. Credit Default Swap
No risk… pic.twitter.com/Ju8l8Aj9YV
— Daniel Lacalle (@dlacalle_IA) April 28, 2023
A credit rating downgrade could also cause investors to look for safer investments, such as investing in another country’s debt. If that happens, it would cause a decline in the value of the US dollar, which would have a ripple effect on the global financial system. It’s like if people stopped investing in a certain company’s stock, the value of that stock would go down.
Finally, if the US government’s credit rating is downgraded, it could shake the confidence of investors and make them less likely to invest in the US government in the future. This could lead to greater instability in financial markets and could hurt the US’s reputation as a global economic powerhouse.
Weakened Dollar
A US default on its debt would not only result in higher borrowing costs and interest rates but also have a severe impact on the value of the US dollar, which is the world’s reserve currency. This would lead to reduced demand for the dollar, making it less stable and reliable.
As a result, a weaker dollar would make imported goods and services more expensive, leading to higher prices and inflation. It would also make borrowing money more costly, which would increase the already heavy debt burden on the US economy. For instance, if the US dollar depreciates against other currencies, it would make it more expensive for US consumers to buy imported goods such as smartphones, laptops, and cars.
Moreover, a weaker dollar would reduce the purchasing power of US businesses and consumers, making it harder for them to compete globally. This, in turn, could hurt US businesses and lead to a decline in economic growth.
Impact on Stock Markets
If the US government fails to pay its debts, it could cause a lot of problems for financial markets all around the world.
Investors and traders would start to worry about the possibility of a default and may start selling off their US stocks and bonds, which would cause the US dollar to decrease in value. This could lead to inflation and make it more expensive for the US government to borrow money.
A default would also cause a lot of chaos in global financial markets and could lead to other banks and financial institutions going bankrupt. This uncertainty could cause a global recession or even worse economic conditions. The effect on the stock market would depend on how long the default lasts. If the default is for a short period of time, it may not have a big impact, but if the default continues in the long term, it could have serious and lasting consequences.
Reduced Government Services
If the United States defaults on its loans, it could result in a decrease in essential services provided by the government. This might mean cuts to programs such as healthcare, education, and social security, which could affect people’s lives. For example, social security payments may be delayed or reduced, causing financial hardship for seniors who depend on them.
Furthermore, there could be fewer government jobs and services, which could impact different areas such as national defense, law enforcement, and transportation. For instance, there could be fewer transportation projects, such as highway repairs, due to budget cuts.
A default could also lead to a loss of public trust in the government’s ability to manage the country’s finances and provide necessary services. This could make it harder for the government to implement policies and make important decisions.
Impact on the Global Economy
A default by the US on its debt would have significant repercussions for the global economy, particularly for developing economies. The US is a major player in the global financial system, and a default on its debt would lead to instability and uncertainty in the capital markets.
The US dollar is the world’s reserve currency, which means that many countries hold US dollars as a store of value and use it for international transactions. If the US defaults, it would undermine confidence in the US dollar, and investors and central banks would likely reduce their holdings of US dollars.
The impact on developing economies would be severe. Many developing economies rely on exports to the US and have significant trade relationships with the country.
If the US defaults, it would lead to a reduction in US demand for imports, and this would hit developing economies hard. This would cause economic contraction, unemployment, and a reduction in living standards for many people.
Moreover, a US default could lead to the emergence of other currencies as reserve currencies. The US dollar has been the dominant reserve currency for several decades, but a default could undermine confidence in the US financial system.
This will result in the emergence of alternative currencies, such as the Chinese yuan, Indian Rupee, and Emirati Dirham. This would have significant geopolitical implications, as it would shift the balance of power away from the US and towards other countries.
Effects on international trade and bilateral relations
The US is a major trading partner and investor in many countries, and a default would lead to a reduction in US investment and trade. This would strain relationships between the US and its partners, and it would also make it harder for the US to achieve its foreign policy objectives.
Countries that hold large amounts of US debt, such as China, would also be affected. They would lose money if the US defaulted, and this would lead to tension between the US and these countries.
Defaulting on the US debt would have severe and global consequences, causing economic shockwaves and potentially losing the US its safe haven status. Rising interest rates, inflation, and a declining US dollar would severely damage the economy, and the government would struggle to maintain operations and provide essential services. Policymakers must take proactive steps to address the debt and avoid default.
