U.S. Default Will Shake Asset Markets

The first warning about the possibility of a U.S. federal government default has come to the fore. Credit rating agency Fitch Ratings announced on June 8 that it would mark as “junk” all U.S. Treasury securities if Congress does not raise the debt ceiling by early August and the U.S. government falls, even temporarily, into default status. Fitch particularly stressed that while the U.S. government bond ratings can bounce after a temporary default, they would not be at the highest “AAA” levels the U.S. has enjoyed for so long. This warning could be seen as one that stems from deep political calculation.

This situation is in line with the well-known fact that the U.S. has barely been patching up its snowballing current account and budget deficits with government bond issues. The problem is that the federal government hit the $14.3 trillion debt ceiling last month. The White House has requested that Congress raise the ceiling to $16.7 trillion, while the GOP insists that such a move must be preceded by appropriate cuts in the national budget. Of course, since Congress will most likely end up agreeing to raise the debt ceiling, there is no real possibility that a potential default would go on for the long-term. The recent high costs of American government bonds are thus more a reaction to weak economic indicators than to concerns of default.

It is another problem entirely, however, if the U.S. sovereign credit rating also takes a toll from the temporary default. A lower American credit rating could have a huge impact on the global economy. Countries running a trade surplus on the U.S. would decrease the purchase of American government bonds while the world’s asset markets would be thrown into chaos. There is a high possibility that this could trigger a rapid contraction in global trade and the world economy as a whole.

Furthermore, the resulting plunging value of the dollar would deal a fatal blow to China, which possesses more than $1 trillion in American bonds. With such a potential scenario looming in the near future, India, Australia and other countries have issued their words of caution. Adviser to the People’s Bank of China Li Daokui has likewise said he “hope[s] that [the U.S.] would stop playing with fire.” Even if there weren’t fears that the Chinese property market will collapse, these are troubled times. All must keep a sharp eye on the possibility of a U.S. default. No one must underestimate the consequences of American politics falling into hazard.