Until 1944, Sterling used to be the global currency. But after the second world war, America with its strong economy and unparalleled innovations, became the super-power of today’s world. Is that era coming to an end ? Possibly.
After the second world war, while most countries were grappling with the basic necessities, America was building weapons inventory and technical know-how. There is peace and prosperity when there is one clear winner. But over the period of last 75+ years, China has built an economy which is parallel to that of US. Things get murkier when there is a close second.
The situation gives rise to geopolitical tensions and the fight for power, comes with collateral damages.
The US Debt trouble
Like many countries across the globe, US government runs a budget deficit. The term may sound complicated but in simple words, it just means that the govt spends more money than it earns from taxes. So, in order to pay the bills like interest on the govt treasury bonds, pension to the retirees, salaries for the soldiers etc, the govt has to borrow more. And how does it do that ? By issuing more treasury bonds.
The US issued bonds are bought by other country govts, institutions and by people across the globe. It is considered to be a risk-free kind of investment for the world where USD is the global currency. Or a AAA rated bond as one might say. People buy these bonds by paying money to US govt but it is not free. Govt has to pay these bond holders an interest and the rate of interest is set by the federal reserves (a body like RBI in India).
Since the govt spends more than it earns, it has to borrow more to pay its bills which comes with more interest payment obligation. This is a vicious cycle. So, to limit the borrowing, the congress has set a debt limit.
What options does the govt have now ?
There are mainly two options. One is to cut down on the spending and stop issuing more bonds OR to increase the debt limit.
Cutting down on the spending involves prioritizing the due payments. Basically, deciding on what bills to be pay first ? If govt decides to stop paying the interest on the bonds, it is going to be catastrophic for the world economy. And if govt decides to delay the salaries for the govt workers, then the fight would be to decide on who gets the salary and who do not. It is not an easy situation to handle.
So, the other option is to raise the debt limit which again is not going to be easy in the polarized political environment. During the similar situation in 2011, the president Barrack Obama could unilaterally decide on the debt limit increase, but there is an amendment that exists which can be invoked by the congress to stop the president from doing that.
“Heads you win, tails I lose” situation for the Federal Reserves
The Feds printed a lot of money and the govt gave it away during the COVID crisis. Inflation was an obvious manifestation of the printing exercise. But the unexpected Russia-Ukraine conflict added fuel to the fire. The inflation hit 40 year high in the US. To curb the inflation, Feds raised the interest rates aggressively. This in turn increased the interest payment on the govt treasury bonds. So, now the govt has to make higher interest payments for the money it borrows. That balloons up the govt debt.
If Feds put a break on the interest rate hike, inflation will reach to unmanageable levels and economy would collapse. But if they raise the interest rates, govt’s interest liability goes up making it riskier to default on the interest payment.
What’s happening now ?
Once the US hit the cap, treasury begins using “extraordinary measures” by suspending some investments and exchanging different types of debt to stay beneath the limit. The Bipartisan Policy Center, which closely tracks the debt limit deadline, estimates that the Treasury will really run out of cash — what’s known as the X-date — sometime around the middle of the year. That’s just a quarter away.
To add on, the recent fall of banking system in the US has made the situation more difficult for the policy makers. When you think you have hit the bottom, life brings more trouble to pull you into the abyss.
While the entire world is in wait and watch mode, only time will tell how steep is the fall. A new world order could just be at the doorstep.