The US government is now stuck in a deadlock, which poses a serious risk not only to them, but to the global economy.
Both Democrats and Republicans are adamant about whether the debt ceiling for the United States government should be increased.
If there is no solution to this impasse, the global economy may have to pay its heaviest price ever.
If Democrats and Republicans don’t agree to let the US government borrow more money, or as they say – raise the debt ceiling, the world’s largest economy will default on its $31.4 trillion debt burden.
Time to reach such a compromise is fast running out. This impasse must be resolved by June 1.
If not, British finance minister Jeremy Hunt warns, the consequences will be devastating.
What will be the impact on the US and global economy if the US government defaults? What effect will it have on the common people of the whole world?
What is the ‘debt ceiling’?
Let’s explain this at the beginning.
In the United States, the law specifies the maximum amount of money the government can borrow.
Major sectors of US government spending are federal government employee salaries, military spending, social security, health care, etc. Along with this are the government’s national debt installments and its interest payments and tax refunds etc.
The U.S. government’s spending ceiling has been rising over the past several decades, as the government spends more than it actually earns.
The borrowing ceiling is now set at $31.4 trillion. But the government debt in the United States reached this limit in January. But the finance ministry of the government is providing additional money to the government in some other ways.
U.S. Treasury Secretary Janet Yellen has warned that if the government can’t borrow more money, by June 1, the government may be in default on its debt.
The effect that will have on the economy
First of all, it’s good to say that none of the experts the BBC spoke to think the US will default.
But what if the debt is paid off?
According to Simon French, chief economist at Panmuir Gordon, an investment fund, if something like this actually happened, it would make the global banking and financial crisis of 2008 seem like a trivial matter. Fifteen years ago, during the crisis of 2008, many of the world’s major banks went bankrupt and the world economy suffered a severe recession.
If the U.S. government’s debt ceiling is not raised, the government will not be able to borrow new money. As a result, the government will quickly run out of money, they will not be able to pay their debts, they will not be able to continue the facilities and services they have to provide to the people.
“Then the government will be forced to stop welfare allowances and other benefits that it gives to the people. As a result, the purchasing power of the common people will decrease, people will not be able to meet their expenses. And ultimately the US economy will suffer,” says Russ Mold, investment director at AJ Bell.
The White House’s ‘Council of Economic Advisers’ has calculated that if the government can’t reach a solution on the debt ceiling for a long time, the US economy could shrink by 6.1 percent.
Mohammad Al-Erian, president of Queen’s College of Cambridge University in the United Kingdom and renowned economist, said that if the United States defaults on debt, the entire US economy will suffer a recession.
This will affect the rest of the world. As in the UK, which trades heavily with the US.
“The United States is a major trading partner with countries around the world. If there is a recession, they will buy goods from the rest of the world much less”, says Mr. Al-Arian. However, he does not think that a recession in the US economy will stop the British economy as well.
Mr. French, however, disagreed with this. According to him, a recession in the US economy means that the British economy will surely go into recession.
Home loan cost will increase
A default on the US debt will not only mean a slowdown in business, but it will affect everything from home loans to more.
Mr. French said that in the UK this would lead to higher home loan costs and higher unemployment.
“It will be a cataclysm,” he says.
But why will the cost of buying a home loan in the UK increase due to a problem in the US economy?
When a government wants to borrow money, they sell bonds. In the US these bonds are called ‘treasury bonds’, and in the UK such bonds are called ‘gilts’. When an investor buys such bonds or gilts from the government, he gets interest from the government on the money invested.
“But if the US government defaults on its debt or even the interest payments, then investors will think, if the US government can default, then there is no guarantee that the UK government will not”, says Mr. French.
Investors will then demand more interest to buy government bonds in the UK.
“The interest rate on any loan is determined based on the riskiness of the loan, be it a home loan or a government loan. So when the U.S. government defaults, that’s a big risk event, and overnight interest rates on all kinds of debt will go up a lot,” he says.
The price of goods will increase
The US dollar is the reserve currency for the entire world.
This means that all commodities traded around the world, from fuel oil to wheat, are priced in dollars.
If the US government defaults, the value of the dollar will immediately fall dramatically.
It may seem like good news for the rest of the world. But Mr. “This means that people who invest in commodity markets around the world don’t know how to price their commodities,” French says.
“When the United States government defaults like this, there is a sudden panic among investors. They will begin to question, what next Japan? Will the same thing happen in the UK? Then what about Germany? After that, who else will be the debt collector”, he says.
“Then we suddenly have to reprice everything. In economics terms, this is called ‘risk premium’, i.e. excess risk. Then the cost of this additional risk will be added to the price of everything. So even the price of bread will go up.”
If the price of everything from food to fuel goes up, the cost of living for billions of people will go up.
Pension will decrease
60 percent of the world’s stock market is in the hands of the United States, says Mr. Mold.
“Therefore, the pension fund’s money invested in US stocks will be at risk. People may not know that their pension money is invested there”, he says.
And if the United States defaults on the debt, it will have a bad reaction in the stock market.
But it is not right to assume that everything is bad news.
In 2011, Democrats and Republicans were locked in a similar stalemate over the debt ceiling, which was resolved just hours before the debt-repayment deadline loomed.
Then the US stock market collapsed. But the panic didn’t last long, with the stock market rebounding after a dramatic fall.
Mr. Mold thinks that the same thing may happen again this time.
He said, “However, it will affect those who are currently collecting pension money. But those who start taking their pension money later may have time to make up for the shortfall in the stock market.”
Why has it become such a big problem in the United States?