Repercussions of the United States Defaulting on its debt

Repercussions of the United States Defaulting on its debt

Repercussions of the United States Defaulting on its debt

United States President Joe Biden and House Speaker Kevin McCarthy couldn’t conclude whether the debt ceiling would be raised or the economy would be pushed to default on its $31.4 trillion mountain debt. The deadline is just a week ahead, sending shivers down to other economies that could face the heat if a deal is not formulated.

The default on loans would send the US economy into a recession. But Washington will not be alone in this mayhem; it will drag down the whole world. The world’s reserve currency and America’s most powerful weapon, the US Dollar, will be badly affected in terms of trust. This event will pull down other currencies pegged with dollars, like the Canadian and Australian Dollars.

Several other repercussions could be the drying up of orders from US sellers to factories in China, Vietnam or the Philippines. Global investors holding high positions in the US Treasury will have to face massive unrealised losses. Almost every country has a significant amount of dollars in their forex reserves; their economy will take a hit as imports will become expensive.

The United States alone will be devastated at every nook and corner of the country if the White House defaults. According to the White House estimates, a brief default could lead to 500,000 job losses. In contrast, an extended default could blow away 8.3 million jobs. A week-long default can cause a loss of 1.5 million jobs.

United States Debt

The world is closely monitoring the developments in debt negotiations because if things go down south, it will be catastrophic for the financial world. The US debt has been a major contributor to its economic prowess and the foundation for global trade. It has gained monopolistic power over global financial activity over several decades. A default can shatter the trust gained over decades as an ultra-safe asset. This would also push the $24 trillion market for Treasury debt into bone-chilling winter, freezing the financial markets and blowing up an international crisis.

Historically, Washington has managed to raise the debt ceiling on time without creating much of a political scene. Congress has raised, prolonged or revised the borrowing cap almost 78 times since the 1960s till 2021. A growing divide in the Congress party, increasing debt and spending, and deep tax cuts have led to the White House garnering criticism regarding the internal party crisis.

Dollar Hegemony

The Dollar is the de facto ruler of the foreign reserves of other countries. As per the data from the International Monetary Fund (IMF), the US Dollar enjoys a whopping 58%t of forex reserves held by the central banks, followed by the Euro with 20% and the Yuan under 3%.

According to the Federal Reserve, 74% of Asian and 96% of American trade was invoiced in US dollars. In the European region, Euro is the dominant player; outside it, the Dollar accounted for 79% of trade.

The Dollar is so reliable that shrinking economies demand payment in dollars due to their tanking domestic currency. In Sri Lanka, shippers recently demanded payment in dollars for the supply of 1,000 containers of necessary food items. They had docked up at the Colombo port as the importers weren’t able to pay suppliers in dollars.

Nihal Seneviratne, a spokesperson at Essential Food Importers and Traders Association, said that they couldn’t trade without dollars.

Treasury Trauma

The US Treasurys are popularly used as collateral for loans, a haven in times of crisis, a hedge against bank losses and a vault for the forex reserves of central banks. This undoubted safety has made the US government’s debts, the Treasury bills, bonds and notes almost risk-free in the international bank regulations. Foreign governments and private investors hold 31% of the Treasury or $7.6 trillion of the debt in the financial markets.

A default would completely shatter this undoubted trust and unchallenged dominance of the Treasury. Global investors would doubt it as a haven. The capital outflow will make a dent in the growth story of the United States.

Since 1960, only once has the US technically defaulted due to a failure of payment on time. As per economists, if it defaults, the US stock market could fall by more than 20%, the economy would contract rapidly around 6%, and millions of jobs will be lost.

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