The world is questioning Washington’s competence, fearing prospect of U.S. default

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What would happen if the most economically powerful country were to default on its debts? It would cause a recession, Treasury Secretary Janet L. Yellen stated this week on CNBC. “I fully expect it would cause a recession as well.”

This impact would stretch far beyond U.S. borders. The U.S. economy would be a major source of turmoil on global markets. Foreign investors in U.S. Treasury bond could face severe consequences, including those from allied countries like Japan which had $1. 31 trillion worth as of July, as well as rivals such as China, which held $1. 07 trillion, according to Treasury data.

While the United States has come perilously close to defaulting on its debts before, there is good reason to be especially concerned about this time. Democrats and Republicans are not willing to compromise. Somehow the country has ended up in a situation where minting a single platinum coin with a face value of $1 trillion or more is one of the more plausible options on the table.

Though not all experts are sure exactly what a U.S. default would mean or how it would play out, one thing seems clear: With or without a trillion-dollar coin, the political dysfunction on display would further erode perceptions of U.S. leadership on the world stage.

A default on debt could wind up being a step too far.

The debt debate reveals a strange paradox at the heart of the U.S. system. The United States is the most powerful economy in the world. Foreign investors purchase U.S. Treasury Bonds because they’re reliable. The bonds provide countries that have large amounts of U.S. dollar accumulated via exports with a place for their money to be safe. However, U.S. bonds can pose a risk to economic stability and economic security.

For a little over 100 years, the United States has had a legal limit on how much money the government can borrow, generally dubbed the debt ceiling. The Congress can set spending and tax terms. However, the Treasury cannot borrow more than a limit set by Congress unless Congress votes to raise the limit.

Roger W. Ferguson Jr. of the Council on Foreign Relations writes that the only other major Western country to have a comparable rule is Denmark. “The closest Denmark came to its ceiling was in 2010, when its debt approached 75 percent of the limit. Afterward, the ceiling was more than doubled,” Ferguson wrote recently for the Council’s website.

Though the United States’ debt ceiling was first implemented during World War I, when President Woodrow Wilson wanted Congress to authorize increased borrowing for the war effort, it has since become a fiercely partisan issue. In the past decade, there have been three vicious and nail-biting debates about debt ceiling.

Usually, the parties reach an agreement at the last minute. This time, however, could prove to be different due to the bitter battle over Biden’s ambitious spending plans. The Treasury expects the debt limit of $28.5 trillion to be reached by Oct. 18. However, Republicans repeatedly blocked efforts to raise the limit. “We’re not in the mood to facilitate their difficult job, to make their difficult job easier,” Sen. Kevin Cramer (R-N.D.) told reporters.

Democrats should instead raise the debt ceiling through a complicated process called reconciliation, Republicans say, even though Democrats backed Trump-era increases. Democrats have shot back, hinting they could change the filibuster — a practice wherein any single member can end debate on legislation unless there are 60 votes to move it forward.

Biden laid the blame firmly with Republicans this week when asked if he could guarantee the United States would not default on his debt. When asked if he could guarantee that the United States would not default on its debt, Biden said “No. “That’s up Mitch McConnell,” Biden stated, in reference to the Senate minority leader.

This Washington war affects the world. While much of American media coverage focuses on the potential domestic consequences of default, such as delays in payment to contractors and Social Security benefits, the global impact is not limited to the United States.

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“Americans would pay for this default for generations, as global investors would rightly believe that the federal government’s finances have been politicized and that a time may come when they would not be paid what they are owed when owed it,” Moody’s Analytics argues.

A default could result in credit-rating agencies downgrading the United States. The U.S. would see its interest rates rise and it would be difficult to buy the currency. This scenario could not only be an economic problem but also a national security issue, threatening key tools of foreign policy like sanctions. Beijing has long hoped that the Chinese yuan could threaten the dollar hegemony.

“A default risks undermining the international reputation of the United States as a reliable and trustworthy economic and national security partner,” as well as “undermining the stature of the U.S. dollar as the global reserve currency of choice,” Defense Secretary Lloyd Austin wrote in a statement Wednesday.

So far, most countries appear to be watching with caution rather than true alarm. China, in the midst of its own debt crisis, is preoccupied. Japan’s new prime minister is focused mainly on political maneuvering. Tobias Harris is a senior fellow for Asia at The Center for American Progress. Harris said, “I wonder if the history of close calls has caused some complacency.”

It does all feel like deja vu. The Economist calls the battle “America’s ritualistic threats of economic self-harm.” Even in 2013, during a previous debt-ceiling debate, foreign policymakers were getting tired of the tumult. “We’re glad a deal has been struck,” an anonymous Japanese policymaker told Reuters back then. “But the uncertainty will remain and it will be the same thing all over again early next year.”

The future will likely see still more debt-ceiling battles. And with Republican politics increasingly hostile to debt-limit increases, it may not be too long before the world finds out what happens when the most economically powerful nation defaults on its debts.

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