Why Does The Global Economy’s Faith Rely Upon The Financial Ability Of USA

If the government of the USA went into default and the situation didn’t get resolved right once, Mark Zandi, chief economist of Moody’s Analytics, warned that “no sector of the global economy would be spared.”The economy of the United States would deteriorate so drastically and so quickly that 1.5 million jobs would be lost, according to Zandi and two of his colleagues, regardless of whether the debt ceiling was to be exceeded for only one week.

Consequences of the Downturn in the USA

According to Zandi and his colleagues’ analysis, the consequences of a prolonged government default would be much worse: US economic growth would slow, 7.8 million American jobs would be lost, borrowing costs would rise, the unemployment rate would increase from the current 3.4% to 8%, and a stock market crash would wipe out USD 10 trillion in the wealth of households.

Naturally, it might not even get to that. A round of debt-limit negotiations between the White House, as well as House Republicans, ended on Sunday, with intentions to pick back up on Monday.

By refusing to increase the statutory borrowing cap, the Republicans are threatening to allow the government to fall into default if President Joe Biden among the Democrats does not agree to significant expenditure cutbacks and other concessions.

The fact that a great deal of financial activity depends on faith in America’s ability to always meet its financial obligations feeds the concern. Its debt, which has traditionally been seen as a very safe investment, is the cornerstone of world trade, which is based on long-standing faith in the USA default might destabilize the USD 24 trillion Treasury debt market, force the financial markets to lock up, and spark a global crisis.

Eswar Prasad, professor of trade policy at Cornell University as well as a senior fellow at the Brookings Institution, described a debt default as “a cataclysmic event with an unpredictable but probably significant fallout on US and global financial markets.”

The threat has surfaced while a variety of threats to the global economy are intensifying, including rising inflation and interest rates, the continuing effects of Russia’s invasion of Ukraine, and the tightening grip of authoritarian regimes. In addition to all that, several nations have begun to doubt America’s dominant position in international banking.

Political figures in the United States have typically been able to increase the debt ceiling before it’s too late by pulling back from the edge. Since 1960, the borrowing cap has been increased, altered, or extended 78 times by Congress, the latest being in 2021.

However, the issue has gotten worse. After years of increasing spending and significant tax cuts, partisan differences in Congress are growing and the debt has increased. Treasury Secretary Janet Yellen warned that if legislators don’t increase or suspend the ceiling, the US may default as early as June 1.

 

According to Maurice Obstfeld, a senior fellow at the Peterson Centre for International Economics and a former chief economist at the International Monetary Fund, “If the reliability of (Treasurys) would become compromised for any reason, it would send waves of shock through the system and have immense consequences for global growth.

Treasurys are frequently utilized as loan collateral, as a safety net against bank losses, as a refuge during periods of extreme unpredictability, and as a storage facility for central banks’ foreign exchange reserves.

Treasury bills, bonds, and notes issued by the US government have a risk assessment of zero under international banking standards due to their perceived safety. 31% of the Treasurys in the global markets, or over USD 7.6 trillion, are held by foreign governments and private investors.

After World War II, the dollar has been the de facto world currency due to its supremacy, making it very simple enabling the United States to borrow money and support a mountain of government debt.

A strong dollar renders American goods more expensive in comparison to their overseas competitors, which puts US exporters at an economic disadvantage. However, increased demand for dollars likewise makes them worth more than other currencies, which comes at a cost. This is one of the vital reasons for the US having annual trade deficits since 1975.

Impact on the global economy

US dollars make up 58% of the total amount of foreign exchange reserves maintained by central banks around the world. The euro, at 20%, is second. The IMF estimates that the Chinese yuan accounts for less than 3%.

96% of trade in the Americas received invoices in US dollars from 1999 to 2019, according to Federal Reserve researchers. The same may be said for 74% of Asian trade. Outside of the European Union, where the euro predominates, 79% of trade was conducted in dollars. Because the dollar is so trustworthy, businesses in certain emerging markets prefer to accept payments in dollars rather than local currency.

Take Sri Lanka, which has been severely affected by inflation including a precipitous decline in its currency. Shippers resisted releasing 1,000 cartons of critically needed food earlier this year until they received payment in dollars. Because the importers couldn’t find the cash to pay the vendors, the shipments stacked up at the Colombo docks.

Speaking on behalf of the Essential Food Importers as well as the Traders Association, Nihal Seneviratne said, “Without (dollars), we are unable to conduct any transaction). We must utilize hard currency, primarily US dollars, while importing.

Likewise, plenty of stores in Lebanon, whose currency has depreciated due to inflation has raged, require payment in US dollars. In response to a financial crisis in 2000, Ecuador “dollarized” (changing its national currency, the sucre, for dollars) and has continued to do so ever since.

When a crisis starts in the US, investors always turn to the dollar as their safe haven. When the US housing market collapsed in late 2008, numerous banks and financial institutions were destroyed, including the once-powerful Lehman Brothers. As a result, the value of the dollar skyrocketed.

Even though we, the United States, were the issue, there was still an issue with quality,” said Clay Lowery, who is in charge of research at the Institute for International Finance, a trade organization for the banking industry. “The buck is king.”

The dollar would climb once more, at least starting out, “because of the unpredictability and the fear,” according to Zandi, should the United States exceed the debt ceiling without settling the disagreement and the Treasury stop making payments. Investors around the world just wouldn’t have any idea where to turn unless they went to the United States, which is where they always go in times of crisis. However, the Treasury markets would probably be shut down. Instead of stocks, investors can switch to US money market funds or prestigious US company bonds.

According to Zandi, growing skepticism would eventually reduce the dollar’s value and keep it low. Lowery, who served as an assistant Treasury secretary throughout the 2008 crisis, envisions that the United States will continue to pay interest to bondholders in the event of a debt-ceiling crisis. Additionally, it would make an effort to fulfill its other debts, such as those owed to retirees and contractors, in the order in which they were due and with the available funds.

The government may pay on June 5 for invoices that were overdue on June 3. Around June 15—when a large number of taxpayers make their anticipated tax payments for the following quarter—there might be some respite.

According to Lowery, “anybody who survives off benefits for veterans or Social Security” would undoubtedly sue the government if they weren’t being paid. Even if the Treasury kept paying interest to bondholders, rating agencies would probably lower US debt.

Even though the dollar still rules the world, it has recently lost some ground as more banks, companies, and investors have shifted their investments to the euro and, to a lesser extent, the Chinese yuan. Other nations frequently dislike how fluctuating dollar values might harm their own national currencies and economy.

By deterring investment from other nations and increasing the cost of debt repayment in dollar terms, a rising dollar may contribute to crises overseas. Some other countries are uneasy about the United States’ desire to utilize the dollar’s influence to inflict financial penalties against rivals and enemies.

But no apparent alternatives have yet surfaced. The dollar is far ahead of the euro. Even more so is China‘s yuan, which is constrained by Beijing’s reluctance to permit the free exchange of its currency on international markets.

However, the drama surrounding the debt ceiling is certain to raise more concerns regarding the huge financial strength of the United States and the currency. Obstfeld added, “Right now, the world economy is in a really precarious position. Therefore, it is pretty irresponsible to add a crisis about the financial strength of US liabilities to the mix.

Proofread & Published By Naveenika Chauhan