Unless the United States Congress raises the so-called “Debt Ceiling,” the US Treasury will run out of money and may default on its debts. This could happen as soon as June 1st.
Republicans in Congress are using the threat of an unprecedented US default and the chaos that would ensue as a bargaining chip in budget negotiations with the Biden administration. At time of recording Congress did not appear to be close to raising the debt ceiling.
As of now, a US default is not a totally remote possibility.
While there’s been a good deal of ink spilled on the implications of a default to the American economy and to high income countries in Europe, there’s been less attention paid to the consequences of a US default on the rest of the world — in particular low and middle income countries.
With that in mind, I interviewed Monica de Bolle, senior fellow at the Peterson Institute for International Economics, about the global implications of a US default. This includes an extended conversation (exerpted below) about how a US default would be felt and experienced by countries in the developing world.
The full conversation (which includes a discussion of how a US debt default would impact US-China geopolitical competition) can be heard by subscribing to the podcast.
Go here to get this episode on your preferred podcast listening app.
Transcript lightly edited for clarity
Mark Leon Goldberg: I wanted to shift gears a bit and ask you more specifically about how a U.S. default would impact the economies of the developing world, specifically lower income countries. You know, one trend we’ve seen really since COVID is that countries in the developing world, particularly in sub-Saharan Africa, have taken on huge amounts of debts and are currently experiencing spiraling inflation. A country like Ghana, for example, is needing to pay half or more of its revenues in debt servicing alone. Presumably, a lot of this debt is held in U.S. Treasury bonds. What does a U.S. default mean for an economy in a situation, say, like Ghana or others like it?
Monica DeBolle: [00:17:23] So that’s an excellent question, because one thing that does happen with developing countries in general — always — is that they show at some point some sort of macroeconomic fragility. So either they have periods of very low growth, and possibly very high inflation accompanying very low growth, or even just very high inflation in general. These are situations that usually lead to countries holding more of a currency that they deem to be trustworthy and strong. So whether it’s Africa or Latin America or even the poorer parts of Asia, what we do see is that these are countries that tend to hold more dollar assets simply because these assets have value — and that value is perceived to be safe and perceived to be stable.
Now, if suddenly you have a situation that leads to a default of Treasury bonds of US debt these countries will find themselves in an even worse situation than they’re already in because they have decided to hold a portion of the meager assets that they have, or the meager wealth that they have, in U.S. Treasury bonds. And then all of a sudden, those Treasury bonds will see their value greatly reduced as a result of a default. So for developing countries, it could be a major blow from that perspective.
So that’s one issue. The other issue relating to your question is debt. Yes. These are also countries that have a lot of debt. A lot of that debt isn’t necessarily in U.S. dollars, but it’s certainly not in these countries’ currencies either. So these debts may be with other countries and where the creditors are located. The debt may be denominated in renminbi, if these loans came from China.
So one way countries manage their debt and their ability to carry debt — and at the same time stave off the possibility of they themselves defaulting — is by holding a large proportion of their central bank reserves in a currency that’s deemed to be stable, which is the U.S. dollar. So the country has high debt, but the country has a lot of reserves in dollars, let’s say. And then all of a sudden the U.S. defaults. Now, the country has a lot of debt, but it has nothing that it can count on to sustain itself because it no longer has these reserves in a currency that is considered to be stable. So that will evidently have a very big effect on these countries and might even tip these countries into a default of their own.
Mark Leon Goldberg: So, having covered development issues for about eighteen years now, whenever there is a stark economic downturn like we saw in 2008, it really does hit the developing world much worse than it hits wealthier countries for all the obvious reasons. And from what you’re saying, it seems like countries in the developing world, particularly poorer countries in Africa, parts of Asia, could experience that kind of double whammy of defaulting on their own debts as a consequence of the U.S. default.
Monica DeBolle: Yes, absolutely. That is absolutely one of the big, big risks related to a U.S. default That does not need to happen. Again, we need to underscore that because the only reason why it would is not because the U.S. cannot pay its debt. It’s simply because there’s the inability to reach an agreement between Republicans and Democrats. So it’s a purely political issue as opposed to an economic or financial one. That alone could have very dramatic consequences for developing countries, and in particular the poorer countries amongst the developing countries spectrum.
Mark Leon Goldberg: And what sort of human impact could you imagine that to have on people living in poor countries?
Monica DeBolle: Well, the human impact is huge. Debt crises actually come with banking crises — one leads to the other and they come together. That would amount to massive economic dislocation and impose a massive cost on these populations. They would see a very sharp increase in unemployment so people would lose their jobs. In situations where you already have very, very poor populations, you would see a worsening of that for sure. So you would see an increase in poverty. You would see an increase in inequality. People’s lives would be very badly hit and very badly hurt. And potentially in a way that is much, much worse or much deeper than what happened in the 2008 financial crisis. Because in the 2008 financial crisis, that crisis was obviously very dramatic and had huge implications around the world. However, the U.S. and other countries were quick to act. And even if there were recessionary impacts all over the place, it wasn’t the type of crisis that had the kind of consequences that this might have. So in other words, we didn’t really see in the 2008 financial crisis a wave of debt defaults in the developing world. We didn’t see that. I mean, obviously some countries fared very badly. Other countries not so badly. But we did not see that kind of wave of default. It would be different this time comparatively.
So given that there are a lot of developing countries already in very high debt, including because we are coming out of the pandemic, we could very well see a wave of defaults hitting the developing world. That has multiplier effects of its own because, of course, if you have a large proportion of the global economy that is suffering from these debt crises, well then the whole of the global economy tips into recession. And that kind of takes a life of its own. You know, it’s sort of a vicious circle that sets in.
Mark Leon Goldberg: So in the event of a U.S. default, are there any policies that could be implemented either by governments around the world or, say, by multinational banks like the World Bank or the IMF that might potentially mitigate some of these negative shockwaves from impacting too deeply on economies in the developing world? Is there anything that can be done?
Monica DeBolle: The sad part is no.
Mark Leon Goldberg: That wasn’t the answer I was looking for.
Monica DeBolle: Yes, I know. When we look at the firepower, for example, of international institutions like the IMF or the World Bank or, you know, other multilateral development banks around the world, they don’t really have the kind of firepower necessary to deal with a shock of this magnitude. So it’s a huge, massive shock that no one is really prepared to deal with because no one has prepared for that situation. It’s a situation that is in many, many ways unthinkable. And it is also unthinkable because it is a situation that, if it happens, is completely self-inflicted and it’s completely irrational. So there hasn’t really been preparation for this kind of situation. No one is prepared to face a shock via a U.S. default. No one is prepared for that. It is an unthinkable. But now it’s not so much an unthinkable, but it is going to catch everybody still wholly unprepared.
Mark Leon Goldberg: Is there any other point you wanted to make or anything you wanted to get in? A question I didn’t ask.
Monica DeBolle: The fact that you have so many of these developing countries that actually are so highly dependent on the dollar because they can’t depend on their own currencies. Think of an economy like Sri Lanka, for instance. They have terrible policies and the currency is just a currency that can’t be trusted. You can think of the same story in Argentina. The same thing. People can’t trust their own currency. So what do they do? They use the dollar instead. In countries like these where there are a lot of economic problems that can’t be solved in the short term, these countries end up resorting to informal dollarization where the dollar is being used.
There is no formal sort of legislation that says that the dollar is legal tender or anything like that. But countries end up using the dollar anyway because it is a currency that’s value is stable and people can trust it and so they can denominate contracts in that currency, they can take on debt in that currency, they can make transactions in that currency. So these economies become highly dependent on the dollar. And then you can think of a situation where the U.S. defaults. Well, then what? Because then these economies are now no longer going to have that anchor of stability that kept them more or less sort of adrift. If you take that away from them, then they’re completely adrift. And so that is one thing that I fear greatly because there are a lot of countries in that situation.