Till US Debt Do Us Part – Analysis
By Observer Research Foundation
By Srinath Sridharan*
The possibility of the United States (US) defaulting on its loan payments is a matter of grave concern, with far-reaching implications for the global economy. As the world’s largest economy, any instability or default by the US could trigger a catastrophic chain reaction, undermining economic stability and eroding global confidence. The spectre of a potential US debt default looms ominously, raising concerns about the repercussions it could unleash on the global stage, that would extend beyond economic consequences.
Known risk, unmitigated yet
The US currently faces an astronomical national debt, with figures surpassing US$28 trillion and climbing rapidly. This staggering number equates to a debt-to-GDP ratio exceeding 130 percent, indicating that the debt burden is outpacing economic growth. The interest on the national debt is becoming an increasingly burdensome expenditure for the US government. In the fiscal year 2021 alone, the US spent over US$378 billionon interest payments. This is a significant portion of the federal budget that could have been allocated to essential public services, infrastructure development, or investments in education and healthcare. The fiscal year 2020 witnessed a budget deficit exceeding US$ 3.1 trillion, fuelled by pandemic-related relief packages and economic downturn. Although stimulus measures were necessary during unprecedented times, they contributed to an already burgeoning debt load.
The fact that the US has been a large debt-led economy or nation has been long known. To a financial regulator or economist, that data itself would have raised risk flags—that a nation keeps changing its debt goalpost with legislative negotiation and semantics to keep its economic trajectory moving on.
The recurring debates over the debt ceiling add further complexity to the situation. The debt ceiling is a statutory limit on the amount of debt the U.S. government can issue to fund its operations. The failure to raise the debt ceiling and meet debt obligations risks triggering a default. In recent years, political battles over raising the debt ceiling have heightened concerns and increased the likelihood of a potential default scenario. The authority to set and modify the debt ceiling lies with Congress. Specifically, it is the responsibility of the House of Representatives and the Senate to pass legislation to raise or suspend the debt ceiling.
A US debt default would trigger severe turbulence in financial markets, destabilising investor confidence and disrupting the global financial system. The US treasury bonds have long been considered a safe haven for global investors, including other nationsholding on to this debt paper. The uncertainty surrounding US debt repayment would undermine investor confidence, leading to increased borrowing costs and market volatility, potentially triggering a domino effect across international economies. The consequences of such a disruption would be felt far beyond US borders, impacting trade, investments, and economic growth worldwide. This could lead to a surge in borrowing costs, increased volatility, and subsequent erosion of wealth and assets on a global scale.
Defaulting on loan payments would tarnish the reputation of the US as a reliable borrower and erode its global standing. The US Dollar’s status as the world’s reserve currency would be threatened, potentially leading to a depreciation of the currency and increased inflationary pressures. As the US economy is closely intertwined with the global economic system, the repercussions of a default would reverberate across sectors, hampering growth, job creation, and overall prosperity.
A default would have severe implications for the credibility and trust in global governance institutions. The nation that nominates the head of the World Bank being a debt-defaulting nation will carry negative implications. The ability of public institutions and legislative stakeholders to reach a consensus and uphold their fiscal responsibilities is critical to maintaining public confidence and trust in democratic governance. Failure to address budgetary issues and prevent a default could undermine the public’s faith in their elected representatives and further erode the foundation of a functioning democracy. A US debt default would strike a severe blow to the fragile global economic recovery. The interconnectedness of economies means that disruptions in one part of the world can quickly spread to others. The loss of confidence in the US financial system could trigger a chain reaction, leading to recessions, job losses, and increased poverty levels globally. This would impede efforts to address pressing global challenges such as climate change, health crises, and inequality.
The repercussions of a US default would hurt its own economy and extend beyond the boundaries of financing ramifications. A prolonged financial crisis could exacerbate income inequality, increase unemployment rates, and strain social safety nets. Essential services, including healthcare, education, and infrastructure projects, may face funding shortages, directly impacting the well-being of American citizens. The ripple effects of such turmoil would have profound social and humanitarian consequences, disproportionately affecting the most vulnerable members of society.
The geopolitical ramifications of a U.S. debt default cannot be understated. As a global superpower, the US plays a pivotal role in maintaining global stability and security. A default would divert attention and resources away from critical international commitments, potentially undermining alliances, weakening diplomatic leverage, and creating geopolitical power vacuums that could be exploited by rival nations or non-state actors. A default by the US could accelerate the ongoing shift in the global order. It could undermine the perceived stability of Western democracies, weakening their soft power and amplifying narratives that challenge the efficacy of democratic governance. This could accelerate potential reshaping of the balance of power on the international stage.
A false sense of security?
Artificial management techniques, such as delaying debt payments or increasing the debt ceiling without addressing the structural issue of excessive and ever-growing debt, provide temporary relief but fail to address the root causes of fiscal challenges. That’s what most global investors would bet on—that this too shall pass. That, finally, the US would agree to increase its debt ceiling, and life would continue as normal.
Such short-term fixes can create a false sense of stability, delaying necessary reforms and potentially exacerbating long-term economic risks.
Implementing prudent financial measures ensures a solid foundation for sustained economic growth and stability. Artificial management techniques merely postpone addressing fiscal challenges, potentially leading to a compounding of issues in the future. By prioritising prudent financial measures, the US can proactively address its debt burdens, reduce reliance on borrowing, and implement structural reforms that promote fiscal discipline. To avoid the catastrophic consequences of a US default, it is imperative for lawmakers to prioritise responsible fiscal management. This includes addressing the national debt, streamlining government expenditures, and promoting sustainable economic growth.
Responsible fiscal policies—like fiscal discipline, effective debt management that involves managing debt situations without additional borrowings, revenue diversification apart from narrow tax revenues, and investments in productive infrastructure—are essential for upholding democratic principles and maintaining public trust in government institutions. Artificially managing debt without enacting necessary reforms erodes transparency and accountability, undermining the democratic process. By embracing prudent financial measures, the US can demonstrate a commitment to democratic governance and reinforce the foundations of a functioning democracy.
The negotiations for increasing the debt ceiling have still not borne any outcome. President Joe Biden is personally driving this negotiation. The debt is due a few days from now—on 1 June 2023. If there is no agreement by then to increase the US debt ceiling, then all hell breaks loose.
While the US is unlikely to default on its debt, its ability for artificial management of the debt issue will hopefully make other nations ask the question: In the long term, how sustainable and safe is a looming US debt default, considering the global economic and market interconnectedness? Especially in the context of global financial stability, till the US debt do us part.
*About the author: Srinath Sridharan is Visiting Fellow at the Observer Research Foundation.
Source: This article was published by the Observer Research Foundation.