If the United States defaults, expect a drop in living standards
Editor’s Note: This article, distributed by The Associated Press, was originally published on The Conversation website. The Conversation is an independent, nonprofit source of information, analysis, and commentary from academic experts.
By Michael Humphries | Touro College
Congress has apparently pushed back the debt ceiling deadline – but the threat of a future default still exists.
On October 7, 2021, Senate lawmakers agreed to extend the government’s borrowing capacity until December. It came after Senate Minority Leader Mitch McConnell proposed a temporary suspension of the debt ceiling, avoiding a default until at least December. But at this point, Democrats should find a way to raise the debt ceiling on their own – which they said they would not do.
This isn’t the first time Republicans have resisted helping a Democratic president raise the debt ceiling.
As an economist, I know this political pool game has real consequences – even if it doesn’t end in default. In August 2011, under the Obama administration, a deadlock on the debt ceiling led to an unprecedented downgrade in the United States’ credit rating, which sent markets plunging.
What is the national debt?
Understanding these consequences begins by examining how the US government finances its spending. The Treasury Department has three sources.
It can use revenue from taxes and fees approved by Congress but collected by the Treasury.
It can also print money through the Federal Reserve.
But when the first two options don’t provide enough liquidity to pay the bills, the Treasury can borrow the difference by issuing bonds and selling them on global financial markets. Bondholders lend the government a fixed amount of money to be repaid with interest over a period of time. The amount owed is the national debt, which currently stands at $ 28.430 billion. That’s above the $ 28.4 trillion debt ceiling set by Congress earlier this year. The Treasury had used “extraordinary measures” to fund government spending instead of an extension, but those measures were due to expire in a few weeks.
While this includes money owed to lenders and investors both overseas and in the United States, a significant portion is money the federal government owes itself – the US Treasury owes money to d other parts of government as part of an accounting process. The Fed buys Treasuries when it wants to increase the money supply in the economy and currently holds about a fifth of Treasury debt. The Social Security Administration holds about $ 2.9 trillion in national debt, which is funded by excess revenue.
Among the largest non-federal institutions that hold Treasury debt are private pension funds.
In total, the Federal Reserve, government and non-government pension funds hold about half of America’s national debt.
What if the United States defaults?
If Congress does not suspend or increase the debt ceiling, the government would not be able to borrow additional funds to meet its obligations, including interest payments to bondholders. This would most likely trigger a fault.
The ripple effect of the US default would be catastrophic.
Investors such as pension funds and banks with US debt could go bankrupt. Tens of millions of Americans and thousands of businesses that depend on government support could suffer. The value of the dollar could collapse and the US economy would likely fall back into recession.
And that’s just the beginning. The US dollar could also lose its unique place in the world as the primary “unit of account”, meaning it is widely used in global finance and commerce. Without this status, Americans simply would not be able to maintain their current standard of living.
A US default would trigger a series of events, including a depreciation of the dollar and spike in inflation, which I believe would likely lead to the abandonment of the US dollar as a global unit of account.
The combination of all of this would make it much more difficult for the United States to buy everything it imports from abroad, and with it the standard of living of Americans would drop.
Michael Humphries is vice president of business administration at Touro College in New York.
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