Global Impact of the U.S. Debt Default due to the Debt Ceiling Crisis

The global economy has experienced two major shocks in the last three years. Now, there are fears that a US debt crisis may cause a third shock. Following the pandemic and Europe’s first major war since 1945, concerns that the US government will be unable to pay its bills are wreaking havoc on financial markets. The consequences of this event could be so gruesome that most people cannot even imagine it. Although negotiations to increase the US government’s ability to borrow are gaining momentum, the aftermath of the default could be far worse than the 2008 global financial crisis.

The smooth functioning of the global financial system is based on the credibility of the US government to pay its creditors on time. This trust has made the dollar the world’s reserve currency and US Treasuries the foundation of bond markets across the globe. If the Treasury’s credibility of payment commitments is called into question, it could cause chaos in various markets worldwide. In the 2011 battle over the U.S. debt ceiling hike, the S&P 500 index, a major U.S. stock, fell more than 15%. The index continued to fall even after a deal was struck hours before the government’s money dried up.

The stock market has mostly avoided a potential default so far, even though the June 1 X date is approaching. Treasury Secretary Janet Yellen has warned that the government could run out of money by then, but is still hopeful that a deal will be reached. If a deal is not made, the financial hit will be more significant, which will significantly affect the US economy, causing a recession. This will directly bring down the global economy. Short-term breaches are more likely, and even if they last less than a week, the US gross domestic product (GDP) may drop by 0.7 percentage points, causing 1.5 million jobs to be lost. A long-term breach will result in more unemployment and more massive GDP loss.

Even though the dollar and US Treasuries have some protection thanks to their large role in international trade and finance, the consequences of a US debt default won’t be severe. However, the bottom line is that everyone will lose, including the US, in the event of a default.

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