Scenarios around the US debt ceiling potential default

By  Maureen Aylward

We asked our Zintro experts about their scenarios regarding the current US debt ceiling issue. If the US does not reach an agreement to raise the debt ceiling, what might happen? We have several perspectives.

Kevin Lenox, an expert in investment management, says that serious action must be taken to reduce government spending, but cooler heads in Washington need to appreciate the unfavorable asymmetric risks of their actions. “There’s a strong likelihood that a US default would immediately provide the trigger for a lower US credit rating. In turn, this could lead to rising interest rates, a falling dollar, and global recession,” says Lenox.

Lenox says that a lower credit rating would cause investors to demand a higher interest rate to compensate for the perceived increase in risk. This would raise borrowing costs for the US consumer and worsen the deficit by increasing required interest payments. “As we’ve seen with countries like Greece, interest rates can move significantly higher if investors lose confidence in the ability of the government to manage its fiscal policy,” he says. “The US dollar would face selling pressures due to the tarnished status of the dollar as the primary reserve currency. As a result, US equities and bonds could face significant headwinds if foreign investors and central banks reduce their dollar denominated assets.”

Lenox explains that a falling dollar provides a lift for commodity prices that might continue to fuel widespread inflationary pressures in many emerging market countries.
“The repercussions from a US default could cause a painful and disorderly decline in global asset prices that could serves as the tipping point toward another global recession. Congress should take a step back and remember the lessons learned from the integrated nature of markets from the Lehman collapse and the fallout after the initial TARP vote.”

Madhaven Iyengar, an international tax consultant, says that if the US defaults on its debt, investors who own US stocks and bonds will take a big hit. “This will affect the big banks, corporations, and even other countries, pushing some toward bankruptcy,” says Iyengar. “The global banking system has such huge exposure in US assets and the dollar that it will continue to have impact until the US raises the debt limit.” For example, when businesses and corporations lose money and cannot borrow to stay afloat, expansion plans get shelved and that can slow down economic progress.

“The US dollar is considered the safest currency in the world, and when it drops, it will create chaos in financial markets. China and Europe will be wary of lending more money to the US. When they do, it will be at higher interest rates and that will affect the global marketplace.” Iyengar says that the dollar is likely to remain under pressure. “As the debt situation continues, countries across the world will lose faith in US Treasuries and will look to diversify to other currencies,” he says.

Jean-Pierre Khordoc, an executive in global development and international finances, says that despite its slow progress due to the rivalry between the two prevailing parties, the US has no choice but to reach an agreement to raise its debt ceiling. “The US cannot afford to take any other action. Anything else would simply bring the world to a major financial collapse and economic meltdown, he says. “In the US, we would be in total disarray with unimaginable financial and economic implications.”

By Maureen Aylward

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