US debt ceiling crucial for world economy
The world watches on nervously as the US teeters on the brink of an unprecedented debt default.
When it comes to giant games of chicken with enormously high stakes for the entire world, nothing quite matches negotiations over the United States debt ceiling.
Over the next couple of weeks, we will either witness two sides of politics reluctantly sign off on an agreement to boost the current US$31.4 trillion debt ceiling or we will all experience an unprecedented and totally avoidable financial Armageddon.
In the past, sanity has always prevailed and negotiations have been successful but this time around the talks between US President Joe Biden and Republican leaders look particularly difficult with the prospect of a US debt default and all of the disastrous economic ramifications that would bring being a very real option.
Debt default would be devastating
According to White House economists, even a short default would see around half a million jobs disappear, driving the unemployment rate up by 0.3% and would also push up interest rates, see share prices fall and crater economic growth.
A longer default would be even more grim, with 8.3 million jobs gone and unemployment soaring by 5%.
Globally, the effect would be massive, with heavy falls in the price of risk assets such as shares and massive disruption and volatility in debt and foreign exchange market as well.
US dollar vital for commerce
Given that the US dollar is the predominant currency used to price most commodities from oil to pork bellies, there would also be a catastrophic disruption to world trade.
All of which raises the question, surely somebody will blink during the negotiations and pull back from the abyss?
It is hard to tell so far, with a debt limit meeting between President Joe Biden and top lawmakers that had been scheduled for last Friday postponed, with the leaders agreeing to meet early this week.
There is plenty of discussion still happening behind the scenes but it will come down to the meeting between President Joe Biden, Republican House Speaker Kevin McCarthy, Democratic Senate Majority Leader Chuck Schumer, top Senate Republican Mitch McConnell and top House Democrat Hakeem Jeffries to really nail down a deal everybody can live with.
Republicans are pushing for tough Budget cuts on a range of programs and even want cuts to Biden’s signature climate legislation that passed along party lines last year.
Understandably, the Democrats are resisting those cuts but will have to at least restrict some future spending levels to get any deal across the line.
Time is running short
Time is obviously running short with Treasury Secretary Janet Yellen saying the country could default on its debt as soon as June 1.
There are still some tricks that could be used to extend that date a little but already the prospect of an impasse over the debt ceiling has raised short term interest rates in the US and is starting to cause other unwanted side-effects.
As Treasury Secretary Janel Yellen wrote in a letter to Congress about the issue, even waiting for a last-minute deal is not ideal.
“We have learned from past debt limit impasses that waiting until the last minute to suspend or increase the debt limit can cause serious harm to business and consumer confidence, raise short-term borrowing costs for taxpayers, and negatively impact the credit rating of the United States,” she wrote.
Financial Armageddon awaits
If the unthinkable were to happen and the US defaulted on its debt for the first time in its long history, the devastation it would cause has been likened to a financial Armageddon.
It would likely cause a massive increase in interest rates, a large crunch on the share market, extreme volatility on money and foreign exchange markets and have devastating effects on employment and the world trading system.
Hopefully just the prospect of causing such devastation will be enough to see both sides in a mood to compromise when they meet this week but politics is a strange game and until a deal is done, uncertainty will remain high.
Should an acceptable deal be reached, then the positive effects would be for a recovery in interest rate markets to restore more normal levels and an unwinding of any suppression in share markets to reflect the greater certainty.
Not a boom, certainly, but a return to more normal levels of confidence that will last until the next time the debt ceiling comes up for negotiation – a date that is also part of the current negotiations.