What will probably happen in Europe if USA goes in default?
What will probably happen in Europe if USA goes in default?
This post will be structured in 2 parts:
Who owns the debt by the government
What would the effects be of defaulting
The US defaulting on its debts has both internal and external effects. The total of US government debt is over $ 16.7 trillion. Of that debt, $ 4.8 trillion is owned by governmental agencies.
This includes agencies such as the social security (holds over $2.5 trillion dollars).
Of the public debt, $5.7 trillion is owned by foreign investors.
Keep in mind this is just the actual government debt, effects of a default would be much bigger
Now, what would happen in case of a default? Let’s assume you own a $1000 bond by the US government. You might think it’s just paper, but that’d be wrong. After all, you paid for that paper. Just like an iPod is worth $500 or whatever because that’s what you paid for it. Bonds are means of (safe) investment.
Now, government defaults. You, the owner of the government bond are unsure about whether you will actually ever get your money back, so you’re freaking out. Then some dude comes to you and says “hey, I’ll pay you $500 for that bond!”. You figure “better be sure” and accept it (this 50% depreciation is completely arbitrary).
Now, let’s assume everyone reacts like you do (which is entirely unlikely but let’s assume so for sake of simplicity). Consequence: the value of the government debt drops by 50% for the owners of that debt. Social security loses over $ 1 trillion, other government agencies or internal investors lose a combined $3 trillion.
To put this in perspective, this is roughly $10 000 per American for a 50% drop. Even assuming just a 1% drop, it’d still be $200 for every American out there. Family with 3 kids? Well shucks, you just lost $1000 (in actual assets or in government benefits, this is on a macro level).
Foreign owners of the debt would see the same effects: the value of their assets would fall. China owns $1 trillion in debt, so loses $500 billion. Same with Japan. Both countries have been rumored of being on the verge of an economic crisis, and this would definitely trigger it.
Worldwide, about $3 trillion in assets would disappear. Again, assuming a 50% value drop which, again, is really unlikely.
Now, let’s look at the much major second-order effects. The dollar would drop in value… really hard. Since the dollar is basically the global reserve currency, a lot of foreign companies (be it from India, Bulgaria, Ecuador… you name it) have dollar bank accounts.
Since the dollar would drop in value versus basically every other currency, a lot of those companies would lose a lot of their assets too. Same (and especially) with the banks.
A whole lot of the global economic system is basically based on the stability of the dollar as a reserve currency. The US defaulting would have an effect on the entire global economic system.
I don’t want to sound like a doomsday prophet here, but if shit actually hits the fan a default would likely lead to a domino effect of banks going bankrupt. Remember when that happened with Lehman Brothers and how hard that one single bank going bankrupt shook the global financial system? We avoided a financial collapse at that point by letting the governments bail them out. Thing is, in this scenario the most (powerful) governments wouldn’t be able to bail them out either.
Then you get to the third-order effects. Banks go bankrupt. Before you all start shouting “YEAH, FUCK THE CAPITALISTS!!!”, this means that everyone who has an account with a bank (savings account, investment account or whatever) will lose their money. Companies, but the average family too.
***I will stress again that this is all worst-case scenario. Just keep in mind that the EU did everything it could to avoid Greece going bankrupt, and then consider the difference between the Greek economy and the US economy on a global scale. Should give you an idea of how bad it could be. This would be far worse than the Lehman Brothers collapse (many people still don’t realise how close we were to a global collapse of the economic system).
Shutdownghazi Day 14 (Oct. 14th)
This meaningless shutdown of the United States Federal Government has entered day 14 and we are still careening towards this coming Thursday’s economic default. So I guess I’ll keep annotating this international embarrassment of a continuing crisis in our government:
Thursday is not the day we hit the debt ceiling. That day, when treasury cannot authorize any additional debt, has already passed. Starting on Thursday, the treasury department can no longer guarantee that they can pay out all incoming bills.
See, for all the complaining about the government not acting like a business…it is actually surprisingly close in terms of accounting. Businesses have accounts receivable (money coming in), just like the government does with its tax revenues, and businesses have accounts payable, and so does the government with its obligations to pay interest on its debt, pay social security, federal workers paychecks, etc…
When a business has more money to pay out then it has coming in, it has three choices: 1. Take on debt to pay the difference 2. Renegotiate the debts/cut its spending 3. Go into default.
Where the business/government comparison splits is in how much easier it is for the government to choose option one or two over option three. Because a business might not be able to take out more debt (if the market doesn’t think it is credit worthy), and negotiating over its outstanding debt is incredibly difficult given the advantages creditors have in bankruptcy proceedings. Cutting spending as a business is also hard because market forces tend to make businesses run as lean as possible to begin with, so there isn’t much “fat” to cut.
The government, on the other hand, has complete control over how much it has to spend. Even if they are “legally” obligated to pay things like social security or medicare, they are also the ones who get to define what they are legally obligated to pay. So in short, if they passed a law saying they no longer have to pay social security checks…then they don’t have to pay that debt anymore.
And as far as issuing debt goes…if you are a country (like the United States) that controls its own currency…you can (short of a law saying you cant) ALWAYS take on more debt to pay your bills. The Federal reserve is obligated by law to buy whatever debt the gov’t sells it even if there is no other commercial buyers. And the Fed is able to do this because they have infinite money…ie they are the ones who “create cash”.
Both of these facts have, up until the past couple years, made US debt the absolute safest place on earth to put your money. Because if you control what you owe, and you control the money supply, then theoretically you should never have to go with option three…ie Default. And with a recessed global economy where there is more of an emphasis on a return “of” capital rather than a return “to” capital…ALOT of people/mutual funds/banks/government put their cash in US debt.
Let me insert another key concept that markets and economics depends on…the concept of the rational actor. It says that, all else being equal…people/companies/markets/governments aren’t stupid. They will choose what is best for them over other worse options. This key concept makes markets stable, because it makes all of the actions of actors in that market more predictable.
We know that Goldman Sachs wont light all of their cash on fire…because that’s bad for Goldman Sachs. We know that Toyota won’t intentionally make an exploding car…because that would be bad for Toyota.
And up until Thursday, the market knows that the US government wont intentionally not pay its bills when the penalty for doing so is so much more severe than the other options presented to it. The penalty for cutting spending is political, the penalty for issuing debt is economic but manageable (given a long list of time tested tools we have to control inflation)….the penalty for outright refusing to pay your debts are catastrophic.
So in short, what happens on Thursday when the US declares that it wont/cant honor its debts? I don’t know…what happens when Goldman Sachs decides to liquidate all of its assets and burn, literally light on fire, all of its cash?
But whatever it is….we know its not good.
Government Shutdown- Oct 2nd
The issue is not the substance of the Republicans’ argument, it’s the tactic. There’s an established procedure for putting in place a law – it passes both Houses of Congress, and is signed off on by the President. Once a law has been passed, it can be repealed or amended through the same procedure. Everybody playing by that set of rules helps keep arguments fair and procedures somewhat predictable.
What the Republicans are doing now is to say – we can’t win both Houses of Congress and the Presidency (which is what it would take to overturn a law that already was passed by all three institutions), but what we can do is use control of the one house that we do have to refuse to fund the government until the President and the Senate change the health care law.
The reason that the President and the Democratic Senate are refusing to negotiate (and should continue to refuse to negotiate) is that they don’t want the House of Representatives to get in the habit of shutting down the government everytime there is some law they disagree with. It’s essentially the exact same argument for why it’s generally considered inadvisable to negotiate with terrorists. There’s a legitimate way for a party in Congress to get its way – through the normal procedure of writing bills, and through the election cycle – and there is an illegitimate way to do so – by holding the government’s operating budget hostage.
I hope to be remembered for my atrocities! 