A default on U.S. government debt would be bad for the country’s economy. It would be terrible for global financial markets. And it would damage the United States’ long-term fiscal health.
Lately, there has been a growing chorus of concerns about how stiffing creditors could affect the country’s ability to marshal alliances and protect itself. For instance, at the Group of Seven meetings in Japan on Thursday, Treasury Secretary Janet L. Yellen warned that default would “risk undermining U.S. global economic leadership and raise questions about our ability to defend our national security interests.”
A week earlier, Avril Haines, the director of national intelligence, testified that in addition to the expected financial turmoil, there was “almost a certainty” that Russia and China would take advantage of a U.S. default by highlighting “the chaos within the United States, that we’re not capable of functioning as a democracy.”
To be fair, the threat to national security would most likely be a several-years-away consequence; the prospect of global financial crisis as soon as three weeks from now is the immediate cause for concern. And these warnings about national security risk might sound somewhat abstract, besides.
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So, let’s talk about some mechanisms through which default could damage the country’s long-term security interests, using U.S. sanctions policy as an example.
U.S. Treasury securities are desirable to buy because they are considered virtually risk-free. They are seen as rock-solid collateral for other transactions, as well as a useful benchmark for assessing the relative riskiness of other kinds of investments. The U.S. dollar has likewise enjoyed its special status as the global reserve currency because the world trusts in our core economic and financial institutions, our commitment to the rule of law, and our willingness to pay our bills.
Now, consider how sanctions work.
The main reason U.S. sanctions have teeth is that people want to do business with the United States, and with U.S. dollars or dollar-denominated assets. Threatening to take away that access can be a powerful tool in getting other nations and companies to behave in ways we like (for example, by not purchasing oil from countries that we consider hostile toward U.S. interests).
Now, imagine (if you dare) that for silly political reasons, there is more uncertainty about whether we’ll actually pay our bills. U.S. debt or U.S. dollars might start to seem like less desirable things to hold, or to peg other transactions to.
If other countries and companies voluntarily become less reliant on dollars, or otherwise less exposed to the U.S. economy, then … well, it’s not really so devastating if we threaten to take away that access.
“We’re able to use sanctions against state targets like central banks because they tend to hold lots of reserves in Treasurys,” says Daniel McDowell, a Syracuse University political scientist who studies financial sanctions. “If you had a diversification away from Treasury bonds to some other assets outside of the U.S., that could diminish the ability of the U.S. to freeze those state assets.”
There are other possible downstream effects.
For example, if creditors start demanding higher interest rates in exchange for lending to us because we’ve revealed ourselves to be deadbeats, that raises U.S. borrowing costs. It then gets harder, or at least more expensive, to support our enormous military (among all the other things the government spends money on).
Now, you might think this scary array of default-related consequences means that President Biden should just give Republicans whatever they want. After all, even the administration’s own cited economic forecasts predict worse damage from default than from adopting the spending caps demanded by House Republicans.
Here’s the problem with this logic.
If you pay a ransom to release a hostage, you encourage more hostage-taking. Biden learned this the hard way in 2011. As vice president, he negotiated a deal to cut spending as an explicit trade for Republican votes on a debt limit increase; almost immediately thereafter, Republicans tried taking the same hostage again, for a different ransom.
This time around, Biden has maintained his strict “no negotiating over the debt limit” stance. Administration officials hope to disincentivize another episode of brinkmanship next year (when, if Biden agreed to the House GOP’s terms, we’d next hit the borrowing limit). They don’t want a repeat of this manufactured crisis year after year — and the constant reminder to the world that we might not be a trustworthy economic or geopolitical partner.
What everyone needs now is an off-ramp: something that allows Republicans to save face, and that allows Biden to maintain his red line that the full faith and credit of the United States can never again be haggled over. Exactly what that resolution looks like, or how lasting it might be, is still up for debate.