The risk of US government default affects the global economy

In the United States, Congress has the power to set the maximum amount that the US Treasury can borrow by issuing public debt. It is what is known as debt ceiling. Currently, that limit is $31.4 billion, a figure that was reached on January 19, 2023. Since then, the US Treasury has resorted to extraordinary measures to continue to meet its financial commitments without exceeding that number.

Janet Yellen, the US Treasury Secretary, has set June 5 as the deadline by which these extraordinary measures can be maintained. On that day, he will have to face the maturity of $300 billion in Treasury bills. If the US Congress and government fail to reach an agreement sooner, the US will not have the funds to meet its financial obligations and will therefore default (default).

What can this mean?

Modern financial systems mount their entire structure on the basis of risk-free assets, which is nothing more than the public debt of the country in question. Is risk free because it is considered that the country will always pay what it owes. If this is not fulfilled, the whole system is in question.

If the US did not pay what it owed, its access to financing would be complicated, credit would contract, economic activity would fall and the unemployment rate would rise.

Internationally, if the US were to default on its debt, we could be facing a global crisis similar to, or even worse than, that of 2008. Investors would lose confidence in US Treasury bonds, causing instability in financial markets , and financial institutions holding large amounts of US debt could face serious liquidity problems.

In addition, countries that hold their foreign exchange reserves in US dollars would see their value decline, affecting their ability to stabilize their economies. This situation could trigger a global confidence crisis, leading to further interest rate hikes, falling investment, and possibly a global recession. According to Janet Yellen, it would be “a catastrophe, an unprecedented economic storm.”

Janet Yellen press conference on April 25, 2023. Source: Bloomberg TV.

From a general point of view, the US has been issuing public debt, and paying it on time, since its founding in 1776, although historically there have been some moments of difficulties.

In 1790, some creditor was left unpaid when Congress assumed the debts of the states that had participated in the War of Independence. 1861, with the Civil War; 1933, during the Great Depression; or the breakdown of the Bretton Woods agreements, during the Nixon government, in 1971, are other examples of these difficulties.

Brief history of defaults

A separate chapter deserves the so-called defaults technicians. A default technical happens when the government temporarily defaults on some payments due to technical or administrative problems. In 1979, the US Treasury delayed payment of $120 million in bonds due to a computer problem.

Between 1995 and 1996, under the mandate of Bill Clinton, there was a situation similar to the current one. The Treasury had to resort to extraordinary measures to avoid default until, in March 1996, an agreement was reached with the Republican Congress to raise the debt ceiling.

The situation was repeated in 2011, during the presidency of Barack Obama. On this occasion, the rating agency Standard&Poor’s lowered, for the first time in history, the rating Finally, the agreement with Congress was reached the same day the deadline expired.

In 2013 the situation was repeated, and the federal government was forced to close for 16 days. During these closures, the provision of public services managed by the federal administration is suspended, except those considered essential, which causes the dismissal of a large number of public employees who, by not performing their duties, are not paid.

Now we are before the gestation of the fifth default technician, this time under the mandate of Joe Biden.

critical and crucial

In short, the situation is critical and its resolution is crucial for the global economy. Although the US has demonstrated a long history of commitment to its financial obligations, challenges of a different nature are occurring every time that make the reform and adaptation of the financial system more necessary. The looming deadline of June 5 once again puts this situation into perspective.

Failure to reach an agreement would not only have serious implications for the US economy, but would also have deep and lasting repercussions for international financial markets. Probably for this reason, a last-minute agreement was reached again. Even so, it is worth remembering the saying: “the pitcher goes to the fountain so much that it ends up breaking”.

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