Catastrophic Impacts: This Is How the U.S. Debt Ceiling Crisis Worries the American and Global Economies

The U.S. debt ceiling crisis, which amounts to about $31.4 trillion, is one of the most controversial crises that occupies the thinking of many worldwide because it is a sensitive financial issue whose repercussions are not limited to the U.S. economy only but extend to global markets.

Recently, U.S. media reported that talks on the U.S. debt ceiling in Congress had stopped abruptly after Republican negotiators withdrew from the room, accusing the White House of obstructing the discussions.

What also sparked controversy were the statements of the White House, which expressed its fear and concern about this sudden stop.

The lack of time and the critical situation prompted the U.S. President to announce the reduction of his travel hours to Asia in order to return to participate in attempts to reach a deal.

Biden says Congress needs to raise the debt limit without strings attached to pay previously approved expenditures, while Republicans under McCarthy’s leadership want the president to agree to deep budget cuts or other concessions to secure their approval.

The U.S. government cannot exceed the level of the debt ceiling set by Congress, and the ceiling was last raised by $2.5 trillion in December 2021.

As political differences over raising the U.S. debt ceiling deepen, there is a looming danger that the U.S. government may intentionally default on its debt for the first time in the country’s history.

U.S. Treasury Secretary Janet Yellen described the crisis as more difficult than before but still hopes that a solution can be found, calling for breaking the deadlock between Republicans and Democrats.

“A prolonged period of U.S. failure to pay its bills on time could lead to a deep recession, increase the unemployment rate by about 5%, and lead to catastrophic global repercussions,” said the White House Council of Economic Advisers in a report recently published.

 

Political Bargaining

World leaders, already struggling with inflation and rising interest rates, are watching with great concern the crisis of raising the U.S. debt ceiling, which threatens the prospects for global economic growth, amid fears of repercussions spreading chaos in financial markets, threatening a deep recession, and undermining confidence in the U.S. economy, according to The Wall Street Journal in its report on May 15, 2023.

Treasury Secretary Janet Yellen warned that not raising the debt limit could spark a constitutional crisis and would result in economic and financial catastrophe for the U.S. and for global economies.

Congress was urged to take action by Yellen in a letter, writing that the longer it waits, the more harm is being done.

“If Congress fails to increase the debt limit, it would cause severe hardship to American families, harm our global leadership position, and raise questions about our ability to defend our national security interests,” she said.

Yellen stressed that it is unlikely that the Treasury will meet all of the government’s debt obligations by early June, which would lead to a default by the United States for the first time in its history, according to Reuters.

Biden and congressional leaders, including House Speaker Kevin McCarthy, held two rounds of face-to-face talks seeking to reach an agreement to raise the debt ceiling and avoid default, but the two sides have not yet reached an agreement, as reported by The New York Times in its report on May 17, 2023.

“I am confident that we will reach an agreement on the budget and that the United States will not default on its debt,” Biden said in brief remarks at the White House.

Now Congress is witnessing a sharp division among its members over raising the debt ceiling, with the Republicans, who control the U.S. House of Representatives, insisting that Biden agrees to significant cuts in public spending in return for raising the debt ceiling. While the Democrats demand an unconditional increase in the borrowing ceiling, they accuse the Republicans of using irresponsible pressures to advance their political agenda.

Biden and congressional leaders plan to resume discussions on the debt ceiling next week, after a meeting between the White House and Republican Party negotiators on the evening of May 20, 2023, made no progress.

The two sides have little time to reach a deal to raise the federal government’s $31.4 trillion borrowing limit or risk a catastrophic default.

According to the BBC, some Democrats in Congress are calling on Biden to concede to the Republicans to cut government spending, which the current U.S. president seeks to avoid so as not to appear weak as he prepares to run in the U.S. elections in the fall of 2024.

In a sign of escalating tensions over a possible default, more than 140 top U.S. CEOs sent a letter to Biden and congressional leaders, stressing the need for a deal.

Biden’s main rival at the moment (Donald Trump) wrote to the Republicans on social media recently, “Republicans should not make a deal on the debt ceiling unless they get everything they want. Don’t back down.”

After that, about 40 Republican senators announced last week: “We will not vote for a text that raises the debt ceiling without fundamental reforms to the budget and government spending.”

 

Global Concerns

A blockage in the negotiation of raising the U.S. debt ceiling to more than $31 trillion between the Biden administration and the Republicans, who control the U.S. House of Representatives, dominated the preparatory meetings for the summit of the leaders of the G7 countries this month, according to The Wall Street Journal.

During a meeting of ministers and finance officials of the group’s countries in Hiroshima last week, officials discussed prospects for the U.S. debt crisis, in addition to other major issues such as dealing with China and sanctions against Russia.

British Chancellor of the Exchequer Jeremy Hunt said during the meeting: “It is a serious threat to the global economy. It would be devastating if the GDP of the United States, the largest engine of the global economy, was derailed by the failure to reach a deal.”

On his part, German Finance Minister Christian Lindner said: “Our eyes are on the United States these days, and we hope for a mature decision regarding the finances of the U.S. government and the associated impacts on the global economy.”

In addition to the G7 countries, Indonesian Finance Minister Sri Mulyani Indrawati said that the uncertainty that occurs every several years in the United States about whether Congress will raise the debt ceiling is beginning to undermine confidence in the United States around the world.

“The world is starting to question whether this is a recurring game that can be solved, or if the world has to start learning to distance itself from this situation eventually... This is not good for the United States,” he added.

Mulyani, who spoke with Yellen during the meeting in Hiroshima, said, “Indonesia is moving to deal with local currencies more in its business dealings in Southeast Asia, rather than using the dollar.”

Brazilian Finance Minister Fernando Haddad said countries should not rely on the U.S. dollar for trade, but said he was not worried about the possibility of a U.S. default.

As investors around the world view U.S. debt as a safe haven, the failure of the U.S. to pay interest on its debt in a timely manner could lead to global repercussions.

If it suddenly appears that the U.S. Treasury is an investment risk, this will lead to the sale of U.S. debt, which may spread the seeds of chaos in global financial markets, and may permanently reduce the appetite of investors who hold U.S. debt securities, according to The Wall Street Journal.

It should be noted that Japan is the largest holder of U.S. debt securities. Bank of Japan Governor Kazuo Ueda warned during the G7 finance ministers’ meetings that the failure of the U.S. government may be a difficult problem to solve.

 

Catastrophic Repercussions

According to a report published by the White House website on May 3, 2023, on the dimensions of the debt ceiling crisis, the crisis in Washington is primarily political and not economic, pointing out that as the crisis continues, it will disrupt financial markets.

According to analysts, the repercussions of the economic crisis began to appear in the U.S. through the crisis that affected major US banks, which closed their doors this year, in addition to the recent decline in U.S. stock indices.

Based on a report by Moody’s credit rating agency, defaulting on debt will lead to an economic contraction and higher inflation.

Economists said that the United States risks entering a recession this year after the Federal Reserve raised interest rates rapidly last year to combat inflation, while the International Monetary Fund expected that the global economy would grow by 2.8% this year.

Moody’s pointed out that the amount of damage depends on the extent of the crisis, explaining that if the default continues for about a week, the U.S. economy will lose about a million jobs, including in the financial sector, which will be severely affected by the decline in the stock market.

However, if the impasse continues for six weeks, the economy will lose more than 7 million jobs, the unemployment rate will rise above 8%, and the economy will decline by more than 4%, according to Moody’s, and the effects will still be felt a decade from now.

According to an analysis published by The Economist on May 3, 2023, the effects of the debt ceiling crisis will not be limited to the United States but will extend to global markets, given that if things reach a dead end, this could affect the confidence of global investors in American assets in general.

If investor confidence in the dollar declines and the U.S. defaults on its debt, a collapse in the value of the U.S. dollar could occur and lead to turmoil in global financial markets.

Many global economies are linked to the U.S. dollar through trade and investment. Thus, in the event of a decline in the value of the dollar, these economies may face difficulties in dealing with foreign exchange and an increase in import costs and debts, which could lead to slower economic growth and higher unemployment rates in those countries.

On the other hand, economists believe that there are ideas that are being proposed to circumvent this ceiling, including minting platinum coins worth a trillion dollars and placing them in the Federal Reserve coffers or declaring that the debt ceiling is in violation of the 14th Amendment, which prohibits questioning the federal debt.

Likewise, the Treasury can issue premium bonds by offering much higher interest rates, and then investors will buy them, thus providing the necessary liquidity to the government, but with the reduction of the nominal value of the debt in order to escape from exceeding the ceiling.