Joe Biden announced over the weekend that he and Republican House Speaker Kevin McCarthy have reached a deal – “in principle” – that would pave the way for raising the debt ceiling and averting a US default on its debts.
This must not be understood as the terminal point in a crisis that threatens the global financial markets many times more severe than the 2008 meltdown. It is at best only the starting point of a slow and grinding process to restore US borrowing as the reliable foundation of the global financial system.
Over the past few weeks, the US equities and bond market have remained surprisingly calm in the face of what could turn out to be a major financial catastrophe. The major institutional investors simply assumed that the US government will work something out in due time to avoid a default.
It was not so much that the major institutional investors were not thinking hard about the impending crisis. It is because that impending crisis has become imponderable.
No one really knows how an event of US default would ricochet across every section and corner of the world’s financial superstructure. A US default never happened before. The US Constitution, no less, commands government to honor debts and pay them on time.
The certainty that the US would promptly pay its debts as they come due is the bedrock of the whole, complex system of financial engagements across the globe. It underpins the stability of the dollar as the principal trading currency. It provides the benchmark against which every other sovereign borrowing is assessed.
If the US defaults, everything else fails. There will never be certainty in the international system. It will as if the Sun lost its gravitational pull and therefore its ability to hold the planetary system together.
The finer details of the agreement reached between Biden and McCarthy will be spelled out in a bill that should be publicly accessible by today. By law, the US House of Representatives will be given 72 hours to consider the measure. They will probably vote on it by Thursday, our time.
That is exactly the deadline earlier set by the US Treasury Secretary to avert a default. After due recalculation, the deadline has been moved to June 5.
There is a way for the US to avoid defaulting on its debts coming due over the next week. This will be by withholding payments on salaries and pensions, shutting down “non-essential” programs such as parks and museums and postponing other areas of spending. But this will cause great economic pain: business closures and millions of jobs in the first few days alone. It will cause a drastic drop in domestic consumption, guaranteeing a recession.
All non-defense areas of expenditure will be exposed to this spending freeze. The chaos that will result from it could cause a stock market crash, more bank failures and the diminution of the retirement fund of every American citizen. We have no commonly acceptable calculation of the ripple effects of all these on the rest of the global economy.
At this moment, we are not even sure the hard-won compromise between the Biden administration and the Republicans in control of the US House of Representatives. The compromise is opposed by a rather significant group of right-wing Republicans in the House, the so-called Freedom Caucus. It is also opposed by the liberal left wing of Democratic legislators. The two extremes could scuttle the compromise, returning all of us to the brink of default.
The world is relying on the skills of Speaker McCarthy to gather the votes to get the compromise measure through and lift the debt ceiling, allowing the US Treasury to issue bonds to finance government operations. But McCarthy is a weak leader. The Republicans have a very slim majority in the House and McCarthy is hostage of his party’s right wing. That wing seems willing to raze the financial system if only to strike a political blow at the Biden administration.
Already, a number of hard right Republican congressmen have announced they will vote against lifting the debt ceiling – even if the details of the deal have yet to be threshed out.
The only way to get this compromise through, it seems, is for moderate Republicans and moderate Democrats to come together and vote as one. That means that both parties will have to junk their respective extremes. This is totally unprecedented in US politics.
Or else, default and recession become inevitable.
Some analysts tell us that by dragging their whole government to the brink of default, the Republicans have won this round. But the long-term loser appears to be America’s financial credibility.
After teetering on the brink of default (assuming the debt ceiling will be lifted at the end of this week), the global financial system can no longer work on the assumption the US debt repayment is a certainty against which we calculate the risk of other borrowers. America’s fractured politics almost guarantees that this harrowing episode will repeat over and over again.
Even if the US escapes default this time around, it has not cured its propensity to spend more than it earns. The US government now holds over $31 trillion in debt. That will continue to rise. Another suspenseful episode such as we have gone through will repeat itself with higher amounts at stake.
America’s spending habits and its circus-like politics will continue to hold the world in its thrall.