Is a US default possible?

(And should we be worried about it?)

The possibility of a default of the United States of America is being conjured up ever more often as the date of October 17, 2013  is approaching without an agreement on the ceiling of the debt having been found (and voted for). For, in the absence of such an agreement, and without a raising of the ceiling of the debt, the American government, which is presently paralyzed in part by a « shutdown » ensuing disagreement on the budget, would no longer be able to reimburse its debt titles arriving at maturity, nor pay interests. The arm-wrestling between Democrats and Republicans seems to have reached historic proportions. The “shutdown” of non-essential federal services following a persistent disagreement is here to make us aware of the seriousness of the situation. The rejection [1], on Saturday, October 12th, of a compromise by the Senate of the United States is here to remind us that what is possible might well end up happening.

A default by the United States still remains hardly probable. It is likely that in the coming days a compromise will be found, a limping one, but still a compromise. It will only push off the deadlines by three to six months and leave a little bit more time for negotiations. But at the present time, if one is to rank events in an order of probability, it is clear that a “limping” compromise is more probable than a default, but also that the latter is more probable than a long-term compromise. However improbable, the risk of a default cannot be entirely discounted.

 

  1. I.     What would a default mean ? 

A default is often presented as a frightful cataclysm [2]. This is in truth somewhat exaggerated, at least in the short term. A temporary incapacity of the United States to pay its debts (principal and interest) would not mean that the country would not repay any of its debt, or that it would not pay any interests. Everybody would understand that this would be a mere accident. But this accident would indeed have consequences in due time, of a monetary as well as of an economic nature, because of its coexistence with the budgetary problem which brought about the “shutdown.”

The first consequence would be the degradation of the mark of the United States, and therefore a steep increase in the interest rates which all American economic actors would have to pay. Now, the American economy is very largely dependent on credit, and therefore on interest rates, be it for household consumption or for business investments. This would have strongly negative consequences on growth, which would very likely go from 2.2% (its present level) to 1% or even 0%. The second consequence, which could in part compensate for the first, would be a sharp drop in the value of the dollar. The Euro/Dollar exchange rate would climb to 1,45 USD, or even 1,50 USD. This would give a little bit of breathing space to American companies, but would sharply penalize Europe and the Eurozone.

A third consequence would come from the persistent incapacity of the American government to engage into expenses which are as of now planned, but not yet financed. As a matter of fact, a number of contracts concerning defense are already being suspended. This has forced Boeing, not precisely the smallest of American companies, to resort massively to leaves of absence without pay for as long as the “shutdown” would last [3]. Such a phenomenon would spread and affect very severely the sector of small and middle companies which benefit of a share of public contracts by way of the Small Business Act. The chains of subcontracting would be broadly affected and this direct, “budgetary” effect would add itself to the “monetary” effect. The United States would brutally plunge into recession.

Finally, as a fourth consequence, the role of the Dollar as an international reserve currency would come increasingly under attack. The Euro would not profit from this, for the Eurozone would be hit full blast by an American recession, but it would give new momentum to Russia as well as to China [4] to seek to implement a new international currency. At any rate, since the 2007 crisis, we observe that both the Dollar and the Euro are decreasing hand in hand in the reserves of Central Banks. In fact, the Dollar’s credibility has been affected for a long time, and a default, be it only temporary, would only speed up the process.

Chart 1

 Réserves BC-1

Source: IMF

These are without question serious consequences, of which one senses that they would trigger chain of effects, particularly as far as the survival of the Eurozone is concerned. The shock of a recession would reverberate there extremely strongly, rendering the life-support politics of which a number of states are now benefiting impossible. Still, we are far from the apocalyptic predictions of Jamie Dillon, CEO of JPMorgan Chase & Co. or of Anshu Jai, co-CEO of Deutsche Bank.

 

  1. II.  What would the absence of a default imply ?

As we have said at the beginning, a default is not, at the present time, the most probable issue. A last minute compromise remains the most likely outcome. But, such a compromise won’t settle anything. The opposition between Democrats and Republicans is far more than a mere political opposition. It is a heads-on conflict between two absolutely contradictory political cultures, the one centered on the development of the Federal State, the other onto a closing-up upon itself. Under such conditions, it is hardly probable that we are going to witness a compromise insuring the stability of the Federal State, but far more likely, a “limping” compromise. And such a “limping” compromise would have consequences not much different from those of a default!

Indeed, the rating agencies would in due time (three months, probably) degrade the mark of the United States, provoking a hike in interest rates. Budget expenses would be reduced, and automatic budget cuts would kick in, all things which would have nefarious consequences for the contractors of the Federal government, be they large, or small and medium companies. The American economy would not benefit from a large devaluation, even if the Euro/Dollar exchange rate could go on climbing at first up to 1.38 USD. Finally, the credibility of the Dollar as an international currency would be affected, albeit not as fast as in the case of a default.

It is interesting therefore to see that the “default” question, even if it remains eminently symbolic, is not what is most important. Growth in the United States is very fragile and it will not be able to resist to these repetitive budgetary crises and psychodramas.

The credibility of the Dollar won’t, either. Sooner or later, sooner in the case of a default, later in the case of a so-called “limping” compromise, we are heading towards a grave crisis which will put into question the international monetary system as well as regional systems, such as the Euro. Confronted with the ineluctable character of this evolution, one might ask if the well understood interest of the European countries would not reside in the dissolution of the Euro and an alliance with emerging countries in order to make out the conditions of a true international reserve currency.

 

Kindly translated by Anne-Marie de Grazia


[1] Kathleen Hunter, Roxana Tiron et Richard Rubin, « Fiscal Impasse Widens as Deal Focus Turns to U.S.  Senate », Bloomberg, 13 octobre 2013, http://www.bloomberg.com/news/print/2013-10-13/fiscal-impasse-widens-as-deal-focus-turns-to-u-s-senate.html

[2] Jesse Hamilton « JPMorgan’s Dimon Joins Jain Warning U.S. Against Default », Bloomberg, 12 octobre 2013, http://www.bloomberg.com/news/print/2013-10-12/jpmorgan-s-dimon-joins-jain-warning-u-s-against-default.html

[3] Challenges.fr, « Shutdown : Boeing menace de mettre des salariés en congés sans solde », 12 octobre 2013, http://www.challenges.fr/entreprise/20131012.CHA5568/shutdowwn-boeing-menace-de-mettre-des-salaries-en-conges-sans-solde.html

[4] Le Monde.fr et AFP, « Un média chinois appelle l’économie mondiale à se “désaméricaniser” », 13 octobre 2013, http://www.lemonde.fr/economie/article/2013/10/13/un-media-chinois-appelle-l-economie-mondiale-a-se-desamericaniser_3494864_3234.html


 


Jacques Sapir

Ses travaux de chercheur se sont orientés dans trois dimensions, l’étude de l’économie russe et de la transition, l’analyse des crises financières et des recherches théoriques sur les institutions économiques et les interactions entre les comportements individuels. Il a poursuivi ses recherches à partir de 2000 sur les interactions entre les régimes de change, la structuration des systèmes financiers et les instabilités macroéconomiques. Depuis 2007 il s'est impliqué dans l’analyse de la crise financière actuelle, et en particulier dans la crise de la zone Euro.

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