2023-05-19 02:50:20
- Dearbel Jordan
- Business correspondent, BBC News
US President Joe Biden is negotiating with Republicans to raise the country’s debt limit
The United States government is currently participating in what may be one of the most costly games of courage in history.
If Democrats and Republicans do not agree to allow the US to borrow more – or, in their parlance, raise the debt ceiling – the world’s largest economy will default on its $31.4 trillion debt.
They must reach an agreement by the fateful “tenth date” of 1 June.
If they don’t, chancellor Jeremy Hunt warned the impact would be “extremely devastating”.
So what does that mean for the economy – and for you?
First, all the experts the BBC spoke to don’t think the US will default on its debt.
However, if that were to happen, “it would make the global financial crisis look like a tea party,” says Simon French, chief economist at investment bank Panmure Gordon, referring to the impending collapse of the global banking industry that occurred in 2008.
If the US does not raise its debt ceiling, it will not be able to borrow more money and will quickly run out of money to cover public benefits and other liabilities.
“Welfare and support payments will stop being distributed to people, which will affect their ability to spend and pay their bills,” says Ross Mould, chief investment officer at AJ Bell. “So it will affect the economy.”
The White House Council of Economic Advisers estimates that if the government cannot reach an agreement on the debt ceiling for an extended period, the economy could contract by as much as 6.1%.
Economist Mohamed El-Erian, chair of Queen’s College at the University of Cambridge, says a default “has the potential to push the US into recession”.
This will have major implications for the rest of the world, including the United Kingdom, which regards the United States as a major trading partner.
“The US is one of the world’s largest trading partners. It will be buying less products than the rest of the world.”
El-Erian does not believe a recession in the US will lead to an economic slowdown in Britain, but French is “100%” sure it will.
Mortgage rates may go up
In addition to hurting trade, French says a US default would cause UK mortgages to become more expensive and cause UK unemployment to rise.
“It would be very catastrophic,” he says.
But why are problems in the US making mortgages more expensive in the UK?
When the government wants to borrow money, it issues a bond or debt securities. In the United States, it is called Treasury bills and in the United Kingdom, it is called gold. The investor gets the government’s interest if he buys treasury bonds or gold.
If the US government does not repay its debt or even pay interest, “investors will look at this and say well, if the US can default, what is to stop the UK from defaulting?” French says.
Investors can then demand a higher interest rate to buy UK government debt.
He says: “Interest rates on debt – whether it’s mortgage debt or public debt – take their cue from the amount of perceived risk and it’s clear that [التخلف عن السداد في الولايات المتحدة] It will be a very risky event, so all debt will become more expensive overnight.”
Prices may go up
The US dollar is the reserve currency of the world.
What that means is that a long list of important commodities such as oil, which is used to make gasoline, and wheat, which is ground into flour to make bread, are priced in dollars.
In the event that the US government defaults on its debt, the value of the dollar is expected to drop sharply.
It seems that this may be good news for people outside the US, but it means that commodity investors “don’t know how to price things,” says French.
image copyright Getty Images
“What you might have with a default in the US is suddenly investors panicking and wondering Is Japan next? Is the UK next? Germany next?”
“All of a sudden we have to re-price everything and in economic terms it’s a risk premium. You get a risk premium added to the prices and so the bread becomes more expensive.”
If food and fuel become more expensive, it will raise the cost of living for millions of people.
Your pension may suffer
The United States accounts for 60% of the value of global stock markets, according to Mold.
“So the chances of people’s pensions being affected by the swing of US stocks is there whether people know it or not,” he said.
Equity markets are likely to react badly to a US default.
But it’s not all bad news.
In 2011, Democrats and Republicans remained deadlocked over the debt ceiling until hours before a possible default.
US stock markets fell. But the panic did not last long and stocks recovered from the sharp decline.
Mold believes that will be the case this time around.
And although people who withdraw pensions now can be affected, he says, “if you’re withdrawing your money irresponsibly or unnecessarily, you have time to make up for it.”
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