US Debt: Why a Default Could Trigger Global ‘Financial Armageddon’

US Debt: Why a Default Could Trigger Global ‘Financial Armageddon’

From our correspondent in the United States,

Alexandre Hamilton would rip off his wig. On Thursday, the United States hit its debt ceiling, forcing the Treasury Department to perform a sleight of hand to secure its June 5 financial commitments. Additionally, there is great uncertainty with a standoff between Joe Biden and the majority of Republicans in the House of Representatives. And the specter of a historic default that could cause a global economic catastrophe.

What is the debt ceiling?

This is the maximum limit of what the US government can borrow. The United States is one of the rare countries to set a cap and give Congress full authority in 1917 to raise it if necessary. The current limit reached on Thursday is $31.4 trillion ($31.4 trillion). Imagine a stack of $100 bills connecting the earth to the moon. The total debt is $94,000 per American, or 121% of annual US GDP.

Bill Gale, economist at the Brookings Institution, recalls an important point that illustrates “the stupidity of the current debate”: “The point when you raise the debt ceiling is not to authorize new spending, but to know whether Congress will support the government.” authorizes borrowing to pay for expenses already approved by Congress.” The irony of the American system is that when elected officials vote on a revenue-spending budget, they “do not automatically authorize borrowing to make up the difference.”

Why is it hanging today?

Raising the debt ceiling has long been an almost automatic process. But since the 1990s it has become a political struggle, especially when, like today, there is a Congress split between the two parties. Republicans, never as concerned about “mortgaging our grandchildren’s future by borrowing from China” as they are when they’re not in the White House, refuse to raise the ceiling without family budget cuts. Joe Biden and the Democrats are applying the American doctrine, succinctly summed up by left-wing economist Paul Krugman: We do not negotiate with “corporate terrorists”.

Why isn’t the United States defaulting today?

“If we hit the debt ceiling, the Treasury Department will use accounting tricks to postpone doomsday,” continues Bill Gale. These are the famous “extraordinary austerity measures” announced by Secretary of State Janet Yellen. In particular, the cessation of payments to several pension, health or disability funds for civil servants and former soldiers and a “period of suspension of debt issuance” until June 5th. After that, the real risks begin.

Has the United States ever defaulted?

If the slogan “In God we trust” is on the banknotes, the American machine works more along the lines of “In Debt we trust”. With the exception of an administrative error in 1979, the United States has never defaulted. For this reason, government bonds are considered safe bets around the world.

What happens after June 5 without an agreement?

During the summer, “the state would default on interest payments or other obligations like military pay, Social Security (pensions), or Medicare (elderly health care),” says Bill Gale. Treasury would no doubt try to set priorities, but there is a legal vacuum and it could end up in court. According to analysts at Bank of America, an outage is “likely in late summer or fall” and could last “a few days to a few weeks.”

Is a defect really possible?

In 2011, under the administration of Barack Obama, the markets had fallen in the face of the threat of insolvency. For the first time in history, the S&P agency downgraded the US debt rating. An increase in the upper limit was agreed at the last second. As with the nuclear deterrent, neither party wants to be responsible for an economic disaster. But the Freedom Caucus Republicans-elect, who have already sent Kevin McCarthy through hell for his election as Speaker, may refuse to back down at this time. Some have tabled the possibility for the Treasury Department to mint a platinum coin and assign it a value of $1,000 billion. But Janet Yellen rejected this magic trick, which was controversial among lawyers.

What would be the consequences of a failure?

Mark Zandi, chief economist at Moody’s Analytics, predicts “financial Armageddon.” An alarmism that Bill Gale does little to dampen: “The consequences of a major deliberate default remain unknown, but predictions range from ‘serious to catastrophic’. With a loss of confidence in the dollar and Treasury bills, a rise in household interest rates and a collapse in Wall Street – and with it, private pensions. “With the impact of the financial planet, this would spill over into the global economy like the 2008 crisis. With economies already on the brink of recession, it would be crazy to risk another global financial panic,” warns the economist. “The chosen play with fire. »