The Global Impact of a US Default

Christine Lagarde, the head of the International Monetary Fund (IMF), has warned the world that the United States risks “seriously damaging” the global economy if no agreement is reached by lawmakers to raise the government’s borrowing limit in the next few weeks. The US government shutdown that happened earlier this week puts a dent into the likelihood of an agreement being reached in time.

Commenting on the recent shutdown, Lagarde said, “The government shutdown is bad enough, but failure to raise the debt ceiling would be far worse, and could very seriously damage not only the U.S. economy, but the entire global economy.” She also added, “the ongoing political uncertainty over the budget and the debt ceiling does not help.” The euro zone faces its own trying times; market volatility and slowing emerging market growth all contribute to a growing global economic situation that is becoming more fragile by the day.

In the event that a new debt ceiling is not reached by the US government in time, the US dollar would plummet. This is bad news for a world economy that has been unable to show sustained signs of life following the crippling world recession of 2008. In a report released by the US Treasury, they are quoted as saying, “The U.S. dollar and Treasury securities are at the center of the international financial system. A default would be unprecedented and has the potential to be catastrophic: credit markets could freeze, the value of the dollar could plummet, U.S. interest rates could skyrocket, the negative spillovers could reverberate around the world, and there might be a financial crisis and recession that could echo the events of 2008 or worse.”

What could this possibly mean for the UAE? Since the UAE dirham is pegged to the dollar, this could have a huge effect on everything from the stock markets to oil revenue and continued investment in the UAE, commented group chief economist at National Bank Abu Dhabi, Giyas Gokkent. He further added that, “Rating agencies would downgrade US credit ratings in the event of default; oil prices will decline if there is slower growth in the US which would adversely affect fiscal and external balances in regional economies, [and] the cost of borrowing for households and companies would rise and dampen non-oil activity. Also, entities, which hold dollar-denominated securities due to the exchange rate peg, including US government securities, could be directly affected by default.”

Global financial markets have not priced in even the slightest possibility of such an occurrence, thereby indicating their view that there is minimal risk of a default by the United States. 

Related articles:

Staying Afloat After Leaving Your Job

Simple Savings Tips

Smart Tips for Personal Finance