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By: Anish Beeram
As a result of failed federal stimulus, a loss in tax revenue, and rising inflation during the coronavirus pandemic, the United States federal government has actively hemorrhaged money, as the federal budget deficit ballooned. Recently, the deficit reached $3.1 trillion, surpassing the size of the US economy. Consequently, over 1 in every 5 American citizens fear the possibility of the United States defaulting on its debt. But despite these worries, the realistic chance of an American default is extremely slim. To understand American financing better, one must examine the international and domestic reasons why the U.S. is safe from rising debt.
In the international economy, America is far too important of an actor to default on its debt. Specifically, the United States holds the world's reserve currency and is bolstered by the market value of the USD. This has allowed the U.S. to carry debt more cheaply than other countries because of the purchasing power held by the U.S. federal government. Global imports and exports across major supply chains in China, Europe, and South America are contingent on a strong American demand, which means an American default would uproot international trade. As a result, the International Monetary Fund will always provide the U.S. with bailout money to ensure the economy stays afloat. America has a unique amount of leverage despite the debt it holds because of how many countries depend on it. Quantifiable, if the United States were to default on its debt, over 37 countries would experience an economic depression because of ripples throughout the global economy. In addition, the United States also has a hidden safety net to prevent a default. The majority of American debt is held by foreign countries and investors through federal bonds issued by the Treasury. These bonds, however, are issued in United States dollars, which is uniquely beneficial for the United States because if the country defaults on debt which is in its own currency, then the value of every bond held internationally is voided. Essentially, if America were to ever default on bond debt, then all international investors who hold the debt would lose the value of their bond. Ultimately, it is more financially beneficial for countries like Japan and China to continue holding onto their debt, which will eventually be repaid, than have America default and lose all prospects of making up revenue. Countries like Argentina, Pakistan, and Russia are not able to access this benefit because while their debt is also held in USD, that is not their native currency. America simply holds too much economic leverage internationally to default on its debt.
Domestically, economic matters become far more complicated.s a result, they require a deep analysis through both of America’s financial metrics: fiscal and monetary policy. Across America, the majority of domestic debt is held through consumers and the financial sector. During the pandemic, domestic debt has been directly exacerbated as the American public has systematically lost money and the banking system has run out of funds. Consumers are incredibly close to defaulting on their own debt, and banks have already begun shutting down. If this continues at the same rate, the American government will have no choice but to call in all consumer debt and default. Currently, the federal government is extremely close to hitting the Congressional debt ceiling, a metric used to quantify American debt, at which point the U.S. government can no longer borrow money, cutting it off from funds. However, the probability of the government running out of funds is minuscule for 3 key reasons.
1) The metric is imposed by Congress, so if it is not met, the legislature can simply increase it. This is extremely likely as it has already been raised before, specifically with the last increase being in 2013.
2) During a pandemic, it is imperative that the government has enough money to stimulate stagnating markets. On a national level, an impending depression outweighs the possibility of increasing debt, which means the federal government will prioritize its constituents and simply take loans regardless.
3) If the government were to run out of funds, that would increase the likelihood of investors attempting to call in small-scale debt because the prospects of returns in the future are extremely unlikely. Essentially, if the debt ceiling is not raised, then market confidence will plummet and negatively impact American markets. Regardless of these contingencies, America is able to escape a default by employing effective monetary and fiscal policy. This is true for two main reasons:
United States monetary policy is centered around the Federal Reserve, America’s central bank. Monetary policy is basically action taken by the Federal Reserve to stabilize prices and grow the economy. Currently, monetary policy is in an extreme double bind because the Federal Reserve’s action has always been to modify interest rates, making it easier or harder for the public to take out loans. However, because of the pandemic, the Federal Reserve dropped interest rates to near zero, effectively hitting the Zero Lower Bound. Despite their best efforts, the economy continued stagnating and they are unable to lower interest rates any further. Interest rate policy is incapable of handling the economic crisis, let alone the debt crisis, but the Federal Reserve has one final option: quantitative tightening. This is where the reserve sucks money out of the economy to increase the federal money supply. They do this by buying bonds from the public at cheap rates, which gives consumers more money while absorbing the excess money in the market. This effectively provides more federal funding, without increasing inflation or sinking American wages, which can allow the federal government to handle a large portion of the debt in the status quo.
United States fiscal policy revolves around taxation and infrastructure to control government spending. Currently, American fiscal policy has been extremely contradictory as the government has issued massive stimulus packages while claiming fiscal conservatism. This is unsustainable and serves no purpose in handling the U.S. debt. However, it can be easily reversed by investing in the most stable assets which make the most returns: infrastructure projects. Economists have debated whether the federal government has enough money to invest in widespread infrastructure projects, and the general consensus is yes because it allows more investment into the government itself. Principally, by investing in infrastructure, the federal government inherently launches job creation initiatives while constructively benefiting the nation’s sustainability since building projects demand increased labor. This employs those who are currently unemployed, which decreases the burden on the federal government to reverse unemployment. Historically, infrastructure has also been followed by waves of private sector investment, which indicates that fiscal infrastructure should spur privatized funding into the federal government. By employing the correct means of fiscal policy, the federal government can generate funding while easing the economic burden on its constituents.
Ultimately, these policy changes in domestic economics will bolster domestic markets and prevent a default on consumer debt from ever occurring.
When looking at whether the U.S. can default on its debt, the international and domestic frameworks all outline that America as a country can never default because of the size of its economy. Regardless of how high the debt grows, every country has a vested interest in preventing an American default. Domestically, policy change can prevent debt from accruing, and while it may not solve for decades of economic negligence, it can alleviate future effects of deficit financing. The United States has far more pressing matters than accumulating debt.
Discussion Questions:
What international motives prevent a U.S. default?
How can the Federal Reserve capitalize on excess money in the market to finance the government?
What role can fiscal policy play in reducing unemployment?
What implications would an IMF bailout have for the future of America’s economy?
What impact does the federal debt ceiling have on the government’s purchasing power?
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