Tuesday, 26 October 2021 08:38 GMT

US default is global economy's ticking time bomb

(MENAFN- Asia Times) TOKYO – In July, Fitch Ratings analyst Charles Seville put out a rather perfunctory report on how the US Congress might handle America's credit rating.

Like most, he assumed lawmakers would be prudent. He spelled out, though, what might transpire if Republicans acted as irresponsibly as they did in 2011, back when Standard & Poor's yanked away Washington's AAA status.

“Failure to raise the debt limit in time to prevent a default – in the absence of a formal way of prioritizing debt service – is a meaningful but remote tail risk to the rating,” Seville said.

Not remote enough, it seems.

On Monday, returned to their 2011 couch. They blocked a bill that would've funded the US government and staved off a default. That action, 10 years after similar Republican Party folly, spooked world markets as rarely before.

It also put the US Treasury Department into damage control mode. On Tuesday, Treasury Secretary Janet Yellen said Washington will run out of options to avoid breaching the debt limit on October 18, pushing the US to the brink of default. This new deadline has markets on edge about the outlook for the linchpin of the global financial system.

Republicans are“playing a dangerous game with the debt limit,” says Mark Zandi, chief economist at Moody's Analytics.

Zandi thinks a deliberate and prolonged debt-payment impasse could cost the US economy six million jobs, destroy as much as US$15 trillion in household wealth, drive unemployment toward 9% from roughly 5% now and devastate global markets.

“This economic scenario is cataclysmic,” Zandi argues.“The downturn would be comparable to that suffered during the financial crisis” of 2008.

It is also playing right into the hands of a Chinese government keen on supplanting the dollar .

Evergrande vs US default

It hardly helps that Washington's debt exploded by $8 trillion during Donald Trump's four years as US president alone. That's more than twice the size of Germany's annual gross domestic product, putting the US on a path to a $30 trillion national debt.

Covid-19 has greatly increased the financial fault lines. Coming on top of the fallout from Trump's trade war, the pandemic slammed growth, tax revenue flows and balance sheets everywhere. It left Group of Seven (G7) governments with fewer fiscal and monetary tools to battle today's stagnant growth environment.

The turmoil also left Asia's biggest economy off-balance, as evidenced by the China Evergrande Group drama. Last week, the globe's most indebted property developer is believed to have missed a bond-interest payment , putting debt markets everywhere on edge.

Yet the shenanigans in Washington are arguably a much bigger threat.

Evergrande's troubles are essentially a domestic affair, one for Chinese President Xi Jinping's government to sort out. And there are early hints Xi's inner circle is working to avert disaster . Reports are that Beijing is urging state-owned enterprises to acquire some Evergrande assets to ease the company's cash crunch.

On Thursday, Evergrande Nanchang, a wholly-owned subsidiary, announced it's selling 1.753 billion non-publicly traded domestic shares in Shengjing Bank, nearly 20% of the capital of Shenyang Shengjing Finance Investment Group. If this is indicative of additional China Inc support to come, the Evergrande saga could soon recede from global headlines.

The Evergrande Center building in Shanghai. Debt restructuring is looking likely. Photo: AFP / Hector Retamal

It's early days, but China may indeed be able to deflate its property bubble in a controlled fashion. If so, this would owe much to China's solid macroeconomic trajectory, one that may see it grow 6% this year – though Goldman Sachs and others have recently revised down their projections in sight of China's debilitating power crunch.

For the US and a national debt surging toward $30 trillion, much of it held abroad, controlled deleveraging is harder – and thanks to a slowing growth rate, less likely to succeed.

That's a problem for everyone as the US dollar is the lifeblood of global trade and finance. In fact, for all Asia's efforts since the late 1990s to wean itself off the dollar, its role has arguably grown.

Nor have efforts by China, Russia, Saudi Arabia, Venezuela unseated the“King Dollar,” as former Trump economist Larry Kudlow called it.

Until now, that is.

Greenback in peril

This latest standoff over the debt limit coincides with worries the Federal Reserve is fanning global inflation risks.

For now, 5% monthly increases in US consumer prices can be explained away as transitory. They can be rationalized as“base-effect” aberrations coming off a year of pandemic-related economic carnage.

The Fed, though, has failed to recalibrate accordingly. It is reluctant even to telegraph moves to“taper” bond purchases to communicate to investors that it's taking preventive steps against inflation. This complacency might not age well if the next two-plus weeks of debt-ceiling squabbles further dent trust in the dollar.

US President Joe Biden risks giving investors even more reasons to turn away from the dollar as Xi's government cultivates yuan credibility. In that, he will be following Trump's White House, which was a dollar-credibility disaster zone.

When he took office in January 2017, Trump had already forged a multiple-bankruptcy path of ruin in the private sector. He brought that ethos to Washington. On the campaign trail in 2016, remember, Trump said that if the US debt got out of control he could“make a deal ,” effectively defaulting.

In 2020, his White House considered canceling parts of America's debt to Beijing.

In office, Trump tweeted early and often that a weak Chinese currency, in his view, was“killing” US living standards. He attacked Jerome Powell, has hand-picked Fed chairman. He toyed with blocking American investors from deploying capital in China, channeling 1990s era Malaysian leader Mahathir Mohamad more than Adam Smith.

These moves only increased the urgency for governments from China to Organization of Petroleum Exporting Countries (OPEC) to dump dollars. The problem Biden now confronts is the progress Beijing has made in this regard.

Is a world in which both the dollar and the yuan function as back-to-back reserve currencies on the horizon? Photo: AFP / Nicolas Asfouri

It was during Barack Obama's 2009-2017 presidency that the International Monetary Fund added the yuan to its top-five currency basket. It was during the Trump years, though, that China vastly increased the number of channels for global investors to bet on yuan assets.

As Xi's team grew the size of China's government bond market – to about $18 trillion now – it lobbied its way into top indexes, most recently the FTSE Russell. Along with getting stocks included in benchmarks like the MSCI, officials established investment channels between Shanghai, Shenzhen and Hong Kong.

Equally important, Xi's government has raced ahead of the US in creating a digital currency. While the Fed and Bank of Japan mull rolling out a central bank-issued digital currency, the People's Bank of China is preparing to give visitors to the Beijing Olympics starting in February access to the future of money .

Concerns about the dollar are also fueling growth in private currencies.

All told,“the dollar lost credibility relative to both the euro and crypto due to Afghanistan and Powell,” says Keith McCullough, CEO of investment research company Hedgeye.“Those are two big arenas – geopolitics and monetary policy.”

American credibility on the brink

America's chaotic withdrawal from the 20-year war in Afghanistan has investors questioning its commitment to globalization. So does Biden's failure to eliminate Trump-era tariffs on China or to rejoin the Trans-Pacific Partnership process. China recently expressed its interest in filling that void and joining the trade group.

The US spent the last 13 years trying to live down the chaos from the 2008 sub-prime crisis. Pushing the global economy to the precipice of a crisis again, and on the heels of the Trump trade war, could do irreparable damage to US credibility.

“We believe Congress will raise or suspend the debt ceiling,” says economist Beth Ann Bovino at S & P Global Ratings.“A default by the US government would be substantially worse than the collapse of Lehman Brothers in 2008, devastating global markets and the economy.

“Should a default occur, the resulting sudden, unplanned contraction of current spending would be staggering. The economy would fall back into a recession, wiping out much of the progress made by the recovery.”

Bovino added that the US was“resilient over the near term, but government bickering over infrastructure proposals and the threat of a government shutdown in October or, more ominously, a debt ceiling crisis, can't be ignored .”

Moreover, she said,“corporate debt levels are high, with a significant amount of it speculative-grade – 'BB+' and below. With a hot economy and interest rates at record lows, bond payments may be currently easy to manage. But when interest rates go up and the economic tide recedes, how many businesses will be left standing without a life preserver?”

Or economies, for that matter. Starting with the world's biggest.


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