What if we default on our debt? (Dylan,
“Subterranean Homesick Blues”)
Bill Barclay.
The debt ceiling,
the dollar and hegemonic currencies
Let’s begin
by clearing up a possible lingering misconception about debt and defaults. If Congress does not raise the debt
ceiling and we default, does that mean the U.S. is broke? No. The U.S., like any country that 1) controls the creation of
its own currency and 2) issues its debt in its own currency, cannot go
broke. However, political calculations
can impose deadbeat status on such a country.
What about
other countries, why don’t they have this problem? The answer is equally simple. With the exception of Denmark, no other wealthy industrial
society has a debt ceiling – and Denmark’s is set at over twice their actual level
of government debt – and it is not a political football. So yes, the U.S. is, as our national
meme says, exceptional. The debt
ceiling – and any associated problems – are our own creation.
In the
global world of finance, a significant part of our exceptionalism is the position
of the dollar as the world hegemonic currency. The issuer of the hegemonic currency, today the U.S., can be
a global debtor while at the same time providing a default risk-free asset
(dollars) to facilitate global trade and capital accumulation. In more prosaic terms, the U.S. can run
a balance of payments deficit while at the same time the U.S. dollar is the
currency of choice for trade as well as for safety in times of financial panic.[i]
Since the
rise of the U.K. as a world power in the early 19th century, the
capitalist world system has known two hegemonic currencies: the U.K. pound
until WWI and the U.S. dollar after WWII. (In the interwar period, the two
currencies shared hegemonic status.)
What if the government
is forced to default because the debt ceiling is not increased?
In what
follows, remember that predictions are very difficult, especially when they are
about the future.
We can think
about both short term and longer term impacts of a debt ceiling-driven default.
In the short term there would be increased volatility in stock, currency and
debt markets. We would likely see
more days like those in Oct. 2008 when Lehman Brothers went under, Washington
Mutual was seized by the FDIC and Merrill Lynch fled into the arms of the Bank
of America. Much of this result flows
from the hegemonic role of the U.S. dollar. If the currency and the debt instruments (treasury bills and
bonds) that are at the core of the world financial system are no longer secure
(as good as gold, as people sometimes say), many large institutions and individual
investors would try to sell assets that were valued in dollars and buy assets
that were valued in – what? The
“what” is both the source of uncertainty and the reason the dollar might
survive a short-term default.
There are, as of today, no
viable alternatives. A few years ago the Euro might have been nominated as the
alternative hegemonic currency, but, due to the ongoing economic downturn in
Europe, the Euro has lost caché
– and value. China’s renminbi (or yuan – your choice) is not yet a viable
candidate.
Consider one
small example of the short-term disruption that a politically-driven default
could cause. There are many institutional investors who can own only AAA-rated
assets, or who must have a large percentage of their debt holdings in AAA-rated
issues – for example, probably your pension fund. If there is a politically-driven
default, it is likely that a second major rating agency would drop their U.S. debt
rating to AA from AAA. (S&P did so in 2011, but neither Moody’s nor Fitch followed
suit.) This would, at least in
theory, stimulate large sales of treasury securities from entities that would
have to seek other AAA-rated debt (such as Canada, Denmark Australia, Finland,
etc). The result would be increased interest rates for additional U.S. borrowing
and thus increased federal government expenditures.[ii]
The possible
long-term results are perhaps more intriguing. Just in the past week, the EU
and China have announced an agreement to denominate a significant portion of trade
between the two areas in the Euro and renminbi (yuan) without the intermediate
step of the dollar. Agreements such as this one suggest the possibility of a
longer-term decline of the dollar’s hegemonic role: no long-running trade
deficits, no currency of last resort during financial panics. If that were to
occur, our privilege of purchasing imports and borrowing across borders more
cheaply than others would evaporate. But capitalism in the modern era has never
functioned without a hegemonic (or, as noted above, dual hegemonic) currency:
we don’t know what the new multi-polar currency world might look like but it
would definitely not be the one we in the U.S. have grown up with.
It seems
surprising that right-wing Republicans want to birth this unknown world
[i] During the
2008 financial panic, holders of financial assets fled to the dollar and the
yen.
[ii] Yields on
T-Bills with maturities in late October have spiked over the past few
weeks.
Bill Barclay is a member of the Oak Park
Branch of Chicago DSA and founding member of the Chicago Political Economy
Group (www.cpegonline.org).
Individually signed posts do not necessarily
reflect the views of DSA as an organization or its leadership.
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