A potential U.S. debt default would have significant global ramifications, extending beyond the borders of the United States. The consequences would be far-reaching, impacting various sectors and countries worldwide. Chinese factories relying on U.S. orders could experience a decline in demand, Swiss investors holding U.S. Treasuries would suffer losses, and Sri Lankan companies would lose their dollar alternative. Mark Zandi, chief economist at Moody’s Analytics, warns that no corner of the global economy would be spared if a U.S. government default occurred and the crisis remained unresolved.
Moody’s economists predict that even a brief breach of the debt limit would cause substantial economic weakening, resulting in the loss of approximately 1.5 million jobs in the U.S. If the default persisted into the summer, the consequences would be even more dire: U.S. economic growth would decline, 7.8 million jobs would vanish, borrowing rates would rise, the unemployment rate would soar from 3.4% to 8%, and a stock market plunge would wipe out $10 trillion in household wealth.
While negotiations between the White House and House Republicans aim to avoid a default, the underlying issue remains concerning. Partisan divisions and increased spending have worsened the problem of U.S. debt. Treasury Secretary Janet Yellen warns that without raising or suspending the debt ceiling, the government could default as early as June 1.
The Treasury debt’s reputation as a safe asset has been a cornerstone of global commerce, fostering confidence in the United States’ ability to meet its financial obligations. A default on U.S. debt would shatter the $24 trillion Treasury debt market, freeze financial markets, and ignite an international crisis. The potential fallout is particularly worrisome as the world economy confronts numerous challenges, including inflation, interest rate surges, geopolitical tensions, and skepticism regarding the U.S. role in global finance.
U.S. Treasuries are widely used as collateral, as a buffer against bank losses, as a safe haven during uncertainty, and as a repository for central banks’ foreign exchange reserves. The United States government’s debt is held by foreign governments and private investors, amounting to nearly $7.6 trillion, or around 31% of Treasuries in financial markets.
The U.S. dollar’s dominant status as the global currency allows the country to borrow and finance its growing government debt with ease. However, a strong dollar can render American goods more expensive compared to foreign competitors, leading to persistent trade deficits. Moreover, the U.S. dollar represents 58% of foreign exchange reserves held by central banks worldwide.
In economies grappling with instability and devalued local currencies, such as Sri Lanka and Lebanon, reliance on dollars for transactions is common. Even during a crisis originating in the U.S., the dollar remains the preferred safe haven for investors. However, should a default occur, initial uncertainty and fear would drive investors to seek refuge in the United States. Nevertheless, the Treasury market would likely freeze, prompting investors to divert funds to U.S. money market funds or bonds issued by top-tier U.S. corporations. Over time, doubts would erode the value of the dollar.
During a debt-ceiling crisis, the U.S. government would prioritize interest payments to bondholders while delaying payments to contractors and retirees until sufficient funds are available. Lawsuits against the government and downgrades of U.S. debt by ratings agencies would be expected. Although the dollar retains its global dominance, it faces challenges as more entities turn to the euro and, to a lesser extent, China’s yuan. The debt ceiling crisis intensifies concerns about the immense financial power of the United States and the role of the dollar.
Given the fragile state of the global economy, a crisis over the creditworthiness of U.S. obligations would be viewed as highly irresponsible. The urgency to promptly resolve the debt crisis and avoid a default is critical, as such an outcome could have severe consequences for both the United States and the world economy.