The world may lose its dependence on US treasury paper
“Extremists … demand to continue spending our money in drunken sailor mode”. This quote from an American politician best describes the heat of passion that now reigns in the United States – and all because this country lives at the expense of the rest of the world and is not going to give it up. If it does, it will be a disaster waiting to happen. So says US President Biden.
The United States is on the brink of economic and financial chaos. That’s what Treasury Secretary Janet Yellen said. And she talks about the threat of default, which now hovers over the U.S. economy. And which is a consequence of both the specifics of the US budget and the inability of the two major US parties to agree with each other.
The fact is that the United States, the largest economy in the world, which through its IMF-like structures teaches others how to spend money, has long been living beyond its means. Government spending is consistently higher than revenue. Politicians are reluctant to cut various social obligations (for fear of not being re-elected in their constituencies), and they spend a lot of money on foreign adventures. And in this situation, the money has to be borrowed – by issuing government debt bonds, which are bought by US citizens as well as external players (including foreign governments for whom these bonds are part of foreign reserves).
And it takes a lot of borrowing. In 2006, US government debt was only $8 trillion – 61% of GDP. In 2014, it reached $17.8 trillion and exceeded the country’s GDP for the first time. By law, the national debt ceiling is set by Congress – and it is always raised when borrowing reaches its limit. The last such increase was in December 2021, and now the ceiling stands at $31.4 trillion. That is 123% of the total size of the national economy.
The problem is that the government has already reached it at the beginning of 2023. Now the financing of spending items in the budget is carried out within the framework of so-called emergency measures (which include, for example, reducing contributions to the pension fund for civil servants, as well as shifting funds between different state structures). However, these measures are temporary – just until the ceiling is raised again.
If it does not happen, the default could come as soon as June 1, according to Janet Yellen. Other experts give the range from early June to early August.
And it will be a disaster. At least this is how US President Joe Biden put it. “I have made it clear that default is not an option… It will be a disaster… Our economy will plunge into serious recession, pension accounts will empty and borrowing costs will rise. According to the international rating agency Moody’s, nearly 8 million Americans would lose their jobs and our reputation in the world would be severely damaged.”
It means that Republicans and Democrats must urgently agree to raise the debt ceiling – for which they must unite in Congress (the upper house of which is controlled by the Democrats, and the lower house by the Republicans) and vote for legislation to this effect.
Cutbacks in the morning, ceiling in the evening
Actually, the Republicans are ready. But subject to spending cuts. “When you give a kid a credit card and he uses up everything on it, you’re not going to blindly raise the credit limit – rather help the kid change behavior and determine where and how he can cut spending. The approach to our national debt should be the same,” said House Speaker Kevin McCarthy. Using their slim majority in the House, Republicans passed a resolution to raise the national debt ceiling by $1.5 trillion in exchange for spending cuts of $4.5 trillion over 10 years – and now want Biden to agree to it.
The move would seem to be a logical one. However, it has clear electoral overtones.
Firstly, this increase is small – technically the law is written so that the US government in March 2024 somehow (even if it does not suddenly reach the new ceiling) will have to bargain with the Congress again. Six months before the elections.
Second, as part of their plan to cut spending, Republicans want to force Biden to drastically cut funding for two of his key programs – green energy stimulus and infrastructure building. Two programmes which should form the basis of the economic segment of the current president’s campaign.
Not surprisingly, Biden and the Democrats refused to support this plan, demanding that the Republicans accept a “clean” (i.e. unconditional) national debt increase. As a result, talks between the two parties have turned from constructive dialogue into a torrent of accusations.
The Democrats are blaming the Republicans for “holding the national economy hostage” by issuing various demands for an agreement to increase the national debt. In addition, Democrats make it clear to voters that agreeing to the Republican demand would mean a drop in living standards for ordinary Americans: cuts in spending on law enforcement, health insurance and more.
Analysts of the White House reckoned that if the country balances on the verge of default to the last, the states will lose 200 thousand jobs because of economic uncertainty. If the default occurs and its resolution drags on, the number of lost jobs will rise to eight million. The figures are 0.3 and 6.1 percentage points for GDP loss and 0.1 and 5 percentage points for unemployment, respectively.
Republicans, on the other hand, say the Democrats’ irrepressible passion for squandering public money left and right is to blame. “Extremist Democrats in the House of Representatives are demanding that we continue to spend our money in drunken sailor mode – otherwise they will undermine our economy and allow America to default,” said Republican Congressman Richard Hudson. According to him, if the Democrats don’t pay the bills they have accumulated, then they will pay at the polls.”
A plague on your homes
And while they argue, economists and the American public are drawing their own conclusions. For example, the financial sector considers the probability of default to be higher than it was during the financial crisis under Obama (the cost of insuring against default on the US debt has risen to its highest level since 2009). The population, on the other hand, continues to be frustrated with politicians who are vying for their sympathies in this strange way.
According to a Gallup poll, only 35% of Americans trust Biden (5% less than last year), while 36% trust the governor of the US Federal Reserve, Jerome Powell (7% less than in 2022). The Democratic and Republican leaders in Congress are 34% and 38% (4 and 2% lower respectively than last year).
Of course, Democrats and Republicans will eventually agree. Or Biden will try to use the fourth section of the 14th amendment to the US Constitution, which says that “the validity of the public debt of the United States authorized by law, including debts made to pay pensions and rewards for service in rebellion or insurrection, shall not be called into question”. It was passed way back in 1868 and dealt more with the aftermath of the Civil War, but now they want to use it to get Biden to take unilateral measures to increase the national debt. This is controversial, it would entail a long legal battle – but it is possible.
But it will not solve the problem of the flawed structure of the US economy, which will continue to live at the expense of other countries. According to some congressmen, in 10 years the national debt will increase to at least $53 trillion under the best of circumstances – which means that the chances of default will only increase.
And this situation threatens not only the US economy but also the global financial system. A number of countries have not just invested in US debt obligations, but made these bonds (because they are supposed to be safe) an important part of government reserves. And now those bonds could turn into nothing more than paper, and at the very least, they could turn into rather unreliable assets (given that every year there will be a similar ceiling hike).
Therefore it is not impossible that politicisation of the situation with the US national debt would be good for the world – it would make it reconsider its dependence on the US Treasury papers. And get out of the status of an American hostage at least on this issue.
Gevorg Mirzayan, associate professor at the Finance University, Vzglyad
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