The US Congress and the Biden Administration are playing a dangerous game of chicken with the world economy.
Failure to raise the government’s $31.4 trillion debt ceiling by early June would lead to a default on the US debt with car crash results for the US and world.
Respected economists Joseph Bruselas and Tuan Nguyen reckon that an “actual default” would lead to US unemployment soaring from 3.4 percent to 12 percent; inflation rising to over 10 percent and the American economy contracting by 11 percent.
Interest rates would rise affecting household and business borrowings. America’s credit rating would be downgraded which would hit the value of the dollar. And since 70 percent of the world’s trade is conducted in dollars, the cost of everything would increase everywhere.
The saying goes that when America sneezes the rest of the world catches cold. The US is the world’s biggest importer of foreign goods and many countries are heavily dependent on the US market for their economic survival.
America swallows 20.6 percent of British exports, 19.2 percent of the European Union; 18.2 percent of Japan’s; 17.9 percent of Indian exports and a whopping 73.25 percent of Canadian exported goods and services.
Any repercussions will almost also include less predictable political and security implications. Empty stomachs create political instability which in turn lead to simple solution promises from the far left or right. They also create openings for autocracies such as China, Russia and Iran.
On Wednesday Speaker of the House Kevin McCarthy said there could be “an agreement in principle” by this weekend to raise the “or suspend” the debt ceiling. He added that this could clear the way for a vote in the House next week. President Biden meanwhile is cutting short an Asia-Pacific tour to return for more talks.
McCarthy’s assurances, however, are suspect because of his lack of control of far-right Republican congressmen. To start negotiations, McCarthy required a vote on a proposal that would raise the debt ceiling by $1.5 trillion contingent on federal government savings of $4.8 trillion. It passed by the narrowest of margins: 217 to 215 votes. Four Republican congressmen voted against and have made it clear that if McCarthy tries to force through anything which does not include big cuts in welfare spending then they will vote him out of the Speaker’s chair and force a default.
And there is the crux of the problem. The Republicans refuse to raise the debt ceiling unless the Biden Administration agrees to cuts in its high profile welfare programmes. These include poverty relief, medicare, and promised relief on student loans. The White House and Democrats in the House and Senate in turn refuse to budge on their signature programmes.
So how can the crash be avoided? The best case scenario is that both sides agree that compromise is the best solution. It remains the most likely but also the most difficult to achieve given the polarisation in Washington politics.
The next is for the president to invoke the 14th Amendment of the US constitution which includes the phrase “the validity of the public debt of the United States shall not be questioned.” This has been interpreted as enabling the president to unilaterally raise the debt ceiling by decree.
This would solve the immediate financial problem but spawn possibly bigger political and legal problems as Article One of the US constitution stipulates that all financial legislation must originate in the House of Representatives and be approved by the Senate. A presidential decree raising the debt ceiling would circumvent Congress and could be construed as breaching the constitution.
Another suggestion is to take the debt ceiling out of the arena of partisan politics by tying it to a percentage of GDP rather than a specific amount. This is the financial mechanism used by most developed countries and means that when the GDP rises so does government spending. The EU, for instance, requires member states to limit their debt to 60 percent of GDP, although the restriction is regularly ignored.
There are disadvantages to this route. It means that in a recession and the GDP drops, spending on welfare will decrease at a time when people need it the most. Also, it seriously blunts one of the political weapons that Congress has in its battle with the president. Politically polarised America is unlikely to accept that.
Meanwhile, the two sides—the White House and Congress- continue to threaten the world economy with their game of chicken and neither side wants to be the first to blink.
* Tom Arms is foreign editor of Liberal Democrat Voice. He also contributes to “The New World” magazine and lectures on world affairs. He is the author of “America Made in Britain,” two editions of “The Encyclopaedia of the Cold War” and “The Falklands Crisis.”
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8 Comments
To whom is the debt owed and by when?
The US debt principally represents pension savings in 401K retirement funds (the US equivalent of private pension funds). Debt held by the public is essentially U.S. Treasury securities — government-issued IOUs — held by the sovereign wealth funds, banks, insurance companies and other private investors, including individuals. The publicly held debt accounts for about 80% of the total Breaking down the $31.4 trillion national debt
Intragovernmental holdings account for the remaining 20%. “Usually it’s things like Social Security or Medicare…”
The treasury holdings are cashed-in to meet pension obligations as they arise and new pension contributions invested in treasuries. In cash flow terms if more is being paid into pension pots then is being withdrawn the government can borrow those savings. Conversely, when demographic changes (an aging population) reverse that trend so that more is being withdrawn from pension funds then is being paid-in the government needs to raise funds elsewhere or increase taxes and social security contributions to meet its obligations.
In the UK, the state pension is an unfunded obligation. When more is being paid out in state pensions than is being paid-in from national insurance contributions the working population will have to pay more in taxes/NI to make-up the shortfall. Likewise with private pensions. If withdrawals from ISA’s and private pension funds exceed payments-in from the working population the government either needs to increase its borrowings elsewhere to roll-over its existing level of debt or raise taxes to repay debt.
In the worst case scenario a state will simply print money and wipe out the value of private savings through sustaining high inflation over a number of years as has historically been the case in debt-ridden economies.
Might it then then the case that, basically, the U.S debt is owed to U.S. citizens?
“America’s credit rating would be downgraded which would hit the value of the dollar. And since 70 percent of the world’s trade is conducted in dollars, the cost of everything would increase everywhere.”
Credit ratings don’t mean anything for a currency issuing government. If the value of the dollar fell relative to other currencies this would make anything that was priced in US dollars relatively cheaper for everyone else.
However, this ‘pseudo-crisis’ isn’t going to be helpful to anyone overall. Fortunately there is a simple work around for any US Federal Administration. They simply create 31 x trillion dollar coins and, hey presto, the National Debt just about disappears. Create an extra one and the Americans have a National Surplus!
It probably won’t be necessary other than to call the bluff of all those who are silly enough to oppose a necessary adjustment in the so-called ‘debt ceiling’. There isn’t any such ceiling and most other currency issuing countries don’t even pretend that one exists for them.
https://en.wikipedia.org/wiki/Trillion-dollar_coin
@ Steve,
“Might it then then the case that, basically, the U.S debt is owed to U.S. citizens?”
Not just US citizens. Its owed to anyone in the world who wants to save their money in US dollars. I have a few US dollars tucked away in a drawer so some is owed to me! The Americans don’t bother to include their coinage in the debt so they don’t the nickels and dimes etc. I’m not bothered either way providing I can spend them on my next visit.
The silliness of it all is that those who are saying the US National Debt is too high are also effectively saying that everyone else is saving too much in US dollar securities. It’s like criticising Barclays bank for accepting too many savings deposits.
Whether the US government debt obligations are represented in the form of securities, notes or coins does not change the fundamentals. If more is being saved in pension funds then is being withdrawn then the savings that the government can borrow against also increases. Conversely, if pension savings turn negative as a consequence of demographic changes than the domestic savings pot available to the government to draw against decreases putting pressure on the abillity to increase debt levels without incurring negative consequences.
The US has very deep and large capital markets that can attract overseas investment with relative ease to compensate for reducing levels of domestic savings. Other countries have a lesser ability to do so and in many cases older populations.
The debt ceiling itself is an artificial construct that Republicans maintain to exert political pressure on government programs. It is almost always circumvented at the last minute.
Not to be confused with a government shutdown that has occurred when congress doesn’t pass a federal funding bill.
If the US government were to fail to make scheduled payments of interest and principal on existing US debt on time that would likely damage confidence in US financial markets raising financing costs for the federal government in the future.
@ Joe,
Once more I think we basically agree. What you are saying, in a roundabout way, is that a increasing volume of private sector savings is a good thing, at least in the short term, because this gives the Government an opportunity to spend more without having to cover its spending with taxation revenue. This does meet with the disapproval of some because of the debt implications.
It is when net non-government savings turn to net withdrawals, that problems may arise. This also means that there will be a higher amount of spending which will, as some will see it, boost the government’s coffers. This won’t necessarily be a good thing! It will mean that the spenders are making greater demands on the productive capacity of the economy and therefore there will potentially be greater inflation pressures.
As always economics is about real things and the real productive capacity in an economy. Getting too fixated on the money flows, as many are doing right now in the USA, doesn’t make for correct policy decisions.
@Peter Martin
The Courts will certainly rule the coin unconstitutional.
Biden should just invoke 14th Amendment.