The game of chickens in the political arena can lead to economic malaise; the United States is on the verge of it. The deadlock between President Biden and Speaker Kevin McCarthy has amplified the severity of the question, “Is the US really going towards a default? This question, even its imagination, is enough to send chills down the spine, for the aftermaths of the ‘unlikely’ US default is going to be catastrophic, not just for the US but for the global economy. As rightly said, “When America sneezes, everyone else catches the cold.”

The US, since 1917, has been setting statutory limits on the total amount of debt a government could raise, which has increased by more than 100 times. The current debt limit stands at $31.4 trillion, already hit in January 2023, after which the borrowing has been halted. The US treasury having $95 billion currently in the bank, requires another $550 million by the end June.

Treasury Secretary Janet Yellen has warned that a default could be triggered from 1 June, and the situation may be aggravated. The scenario may be unforeseen, as the US has never defaulted ever on its debt, apart from 1979, when a technical glitch led to delayed bond repayments. In 2011, the US managed to duck and run the default through a last-minute deal, which led to a downgrade of the country’s top-notch credit rating.

The ramifications of a deadlock in the negotiations, thus triggering default, may be cataclysmic. Any limbo may mean the government runs a deficit. The financial markets will be in turmoil as US debt is the safest asset enabling the government to borrow relatively cheaply. Any missed repayment will trigger a breakdown, raising interest rates and causing the stocks to fall by around 20 per cent, thus shedding $10tr in household wealth as per Moody’s Analytics.

US dollars make up almost 58pc of global forex reserves but the ‘safest asset’ may also observe a fall in its credit rating

A spike may be observed in the borrowing cost, which is already on a hawkish trend. This would further complicate obtaining loans for setting up a business and may raise the federal borrowing costs by $750bn over the next decade.

Moreover, US dollars make up almost 58pc of the forex reserves of the world’s central banks. The default may sabotage the dollar’s prestige, which is already losing dependency on international trade. The ‘safest asset’ may also observe a fall in its credit rating. Fitch has already put the US rating on a negative watch.

The government may not possess enough liquidity to honour social security and health insurance payments to more than tens of millions of American families. This may reduce consumer spending, consequently hurting businesses. The close shave in 2013 resulted in a loss of $2.4tr in household wealth. Any missed repayment may add fuel to the fire and jeopardise the already slowing global economy.

All eyes are on the two political figures, Biden and McCarthy. They are faced with the onerous task of coming up with a feasible solution; however, the current impasse has poured cold water.

The demand of Republicans to slash budget spending by $4tr, followed by Democrats’ insistence on keeping the budget spending flat, has so far kept any deal at bay. Even in the case of a last-minute deal, the treasury will have to expedite raising money through bills, which may lead to a liquidity crisis followed by a surge of 25bps in the policy rates, which are already 5pc higher than in March 2022. The dialogue between the two politicians of the US will decide the fate of the global economy.

The case of the US, followed by the aftermaths of what has been happening in Pakistan since last year’s government change, reinforces the importance of political stability for economic growth.

The US, despite being an economic superpower, is vulnerable to political discords. A similar situation has been observed in Pakistan, where the political conflict has inflicted a serious blow to the country’s economy, which is nearly escaping default. The growing uncertainty has caused havoc in the economy.

Thus, it is highly essential that the political leaders avert flexing muscles, and a consensus should be developed on economic matters among all the stakeholders to impede the uncertainty. Else, all should remember the game of chickens benefits no one!

Published in Dawn, The Business and Finance Weekly, May 29th, 2023