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U.S. debt default would trigger ‘pandemonium’

Former minister of state for finance ‘hopeful’ of a deal to avoid economic calamity
  • James Smith.

ALISON LOWE
Guardian Business Editor
alison@nasguard.com

Published: Oct 16, 2013

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The world has “never been this close” to a U.S. debt default, an event which a former minister of finance yesterday indicated would trigger “pandemonium” in the global, and by extension the Bahamian economy.

As the two sides of the U.S. political divide yesterday entered 11th hour negotiations over the question of whether to raise the U.S. debt ceiling, former Minister of State for Finance and CFAL Chairman James Smith said that he is “hoping” we do not see the “far reaching consequences” for the global economy of a debt default that would be triggered tomorrow if the U.S. fails to reach a compromise.

“I am hoping it doesn’t go, because we’ve been very close before but never this close.  The implications are much more far reaching for the wider world than for The Bahamas, in the sense that the U.S. dollar is the reserve currency and the investments in U.S. paper - treasury bills and bonds - most countries’ central banks are holding that paper, and they hold it for the simple reason that they regard it as a very good, sound investment in the most productive country on earth.  If that confidence is shaken on a global basis it could have repercussions around the world.  I think there’s a school of thought in the U.S . who think it’s not a big deal, but believe me it is.”

Smith said a default would lead to an end of the confidence in the U.S. dollar as the world’s reserve currency that has undergirded the international monetary system for decades, and could essentially result in a “new world order” from a monetary perspective.

The possibility of such an unprecedented event comes as the country, the world’s largest economy, is in the midst of a shutdown of the federal government that has extended for 15 days so far, precipitated by Republican politicians who have made the passing of a new budget to fund the government’s operations conditional on unravelling U.S. President Barack Obama’s flagship healthcare law.

The U.S. Treasury itself has warned of the “profound” consequences of a potential default that “could last for more than a generation”, including high interest rates, reduced investment, higher debt payments and slow economic growth.

“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,” said the U.S. Treasury in a report issued this month.

Smith said he hopes “saner heads will prevail” and an agreement can be reached to extend the debt ceiling.

Highlighting the implications of a default, Smith said it would have massive knock-on effects throughout the global financial system given the extent of U.S. debt holdings, including by the Central Bank of The Bahamas.

“Every day, every hour the U.S. has to make some payments to its creditors, its bond holders, who in turn have got to make payments to settle their commitments as well.  It’s one thing to say ‘well they’ll get around to paying me’, but if you’re late then I’m late, and we’ve got a problem...” said Smith.

“The whole economic system is based on a high degree of confidence by participants and when you have a leader like the U.S. you expect to be paid, you hang our hat on that, if that is disrupted you have to go back to the drawing board and establish new relationships.”

Markets

Meanwhile, the economist added that financial markets have as yet failed to react all too negatively to the possibility of a default, suggesting they do not believe it is likely.

This would make “pandemonium” all the more likely should a default in fact occur, suggested Smith.

House Republican leaders rushed out a new proposal Tuesday afternoon that would reopen the government through December 15 and extend the government’s borrowing authority until February 7.  Speaker John Boehner was hoping to bring a bill to a vote as early as Tuesday evening, although it was unclear if this would happen up to press time, or what the outcome of the vote would be.

Meanwhile, even if passed, the result would only be further negotiations before the next deadline early next year.

Zhivargo Laing, former minister of state for finance under the former Ingraham administration, said he too is “hopeful” for a deal.

“I think we have significant reason to be concerned about it because if there is a default it could have a significant negative impact on the U.S. economy, and impact not only global economic prospects but certainly The Bahamas.”

“All the information I have says that it’s likely they will reach a deal.  I think there are sufficient people on both sides of the divide that appreciate the U.S. economy cannot afford a default, that the economy is still vulnerable, that growth is not at the level they would like, and that a default could send a very bad shockwave through the financial community and have real consequences for Main Street.”


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