The dramatic effects of an American bankruptcy

The dramatic effects of an American bankruptcy

We are now a week away from when the cash reserves of the American public will be exhausted, at least according to the estimates of the most competent person, the Treasury Secretary Janet Yellen. If by then no agreement has been reached between the two American political factions to increase it maximum borrowing limit of the US government (debt ceiling), the consequences could be very important for the economy and international markets.

Currently, this limit is $31.4 trillion, having increased by at least eighty times since 1960 until now. As is known, the main representatives of the two factions, namely the Democratic President Biden and the Republican Speaker of the House of Representatives Kevin McCarthyengaged in relevant negotiations for weeks, assuring public opinion that a solution to the problem will be found in time.

But the truth is that it is not very easy to reach an agreement, since it will have to be approved by both Parliament and the Senate. With the climate between the two parties extremely polarized and the presence of several cadres, in both factions, who can easily take things to extremes, the possibility of an “accident” is not at all negligible.

Indeed, according to the team of economists at JPMorgan Chase, this probability was 25% on Wednesday and rises as the hours pass and negotiations continue without result. A big thorn is that the Republican Party demands it cost reduction hundreds of billions of dollars (maybe even trillions) of the federal budget in order to give him his approval. This does not sit well with the Democratic side and makes Joe Biden’s negotiating position difficult.

So what if both sides can’t get legislation through both houses of Congress before the day the US government runs out of money? We don’t need to look far to tell. We have before us statements by Finance Minister Janet Yellen and estimates by White House economists.

Yellen has repeatedly stated that a potential default on the US Treasury would have “catastrophic effects” on the US and international economies and international stock and bond markets. He warned of a global economic slowdown that would jeopardize the economic recovery that followed the pandemic. Another disastrous consequence will be a major upheaval in the exchange rates of the dollar with other international currencies, which will cause serious problems in international trade.

The estimates of the White House economists are a little more precise and foresee three scenarios: that of a rapid settlement of the file after tough negotiations, that of a temporary suspension of payments and that of a prolonged suspension of payments in because of the impossibility of a political agreement. . Even in the most positive scenario, that of avoiding a default after negotiations, White House economists estimate that there will be negative consequences, such as the loss of at least 200,000 jobs and the GDP down 0.3%. But what is horrifying are their predictions about the consequences of a prolonged default, that is, a three-month period during which the US government will be unable to pay a significant portion of its obligations to its creditors and American citizens.

In such a case, economists estimate that up to 8 million jobs will be lost and a stock market panic will occur with the The US stock market will lose 50% of its value. The last assessment seems outrageous, but we must remember 2011, when we experienced a similar situation. Despite the deal being done two days before the day the money was supposed to run out, the S&P 500 index lost 19% of its value within weeks of the deal being struck.

The truth is that things were a bit different then, with Europe being tested by the debt crisis in various countries, while the downgrade of US government debt by ratings agency S&P had also play an important role. Of course, speaking of rating agencies, it must be said that two of the best known, the Fitch And DBRS Morningstar, took a small step to show its concern over the apparent lack of consensus in the consultations between the two parties. Both agencies, Fitch on Wednesday and DBRS Morningstar on Thursday, reviewed US debt with a downward revision outlook. Both rate the United States at the highest possible AAA rating and believe that a deal will eventually be reached even at the last minute, but have apparently decided to issue a small warning.

Minister Yellen’s warnings certainly have a political element and may contain elements of exaggeration. We don’t know if the same is true for the White House economists, but their predictions about the consequences of a prolonged partial default give us a good idea of ​​what could happen to the markets if we defaulted even- what a day .

We don’t know if the stock market will lose 50% of its value but it certainly won’t react positively at all no matter how much it prefers to play its new game. Wall Street, artificial intelligence. Of course, the problems will not be limited to American stock exchanges, since we know that international stock exchanges generally function as communicating vessels. It is also certain that in such a case there will be a great disruption of international exchange rates, as Yellen has already pointed out. As strange as it may seem, we don’t know whether this will take the form of a sharp depreciation or a strong appreciation of the US dollar.

The first thought goes to a devaluation due to market anxiety, but the reverse could also happen as many may choose longer-term US Treasuries as a safe haven, assuming this turmoil will be temporary (as c is almost certainly the case anyway). Speaking of safe haven, we also think of gold, but knowing that if the US dollar ends up rising, as it did during the corresponding crisis of 2011, gold could be affected because we know that a strong dollar rarely benefits him. We clearly saw something like this last year and we have to keep that in mind. In the event that the dollar reacts higher, it is very likely that we will also see a significant drop in the price of various commodities.

The worry about it debt ceiling it may turn out to be an unnecessary alarm, which it most likely is. But the 25% probability given by JPMorgan Chase economists to the possibility of an “accident” is far from low. Despite the fact that we believe that even if the deadline passes, the solution will be found fairly quickly, we must not ignore the chaotic situation prevailing in American political life.

A few days ago, the former president and now new candidate donald trump he publicly urged Republican lawmakers to push the envelope and force Democrats to accept multi-trillion dollars in federal spending cuts. Without pretending that Kevin McCarthy will follow the example of the former president, we emphasize that understanding between the two main parties is much more difficult now than it was in 2011.

So, for better or for worse, stock market players would do well to limit the risk they take, at least until the white smoke clears from American capital.

Leave a Reply

Your email address will not be published. Required fields are marked *