Global Effects of a U.S. Government Default

Due to recent economic events in the United States, previously dormant terms have surfaced as household conversation topics.  Many in the modern workforce had never considered the consequences of a government shutdown, let alone knew what that term meant.  Once the shutdown was a reality, the possibility of a government default surfaced as well.  The shutdown ended and the possibility of a government default in the near future may be less threatening than earlier this year, but the possibility still looms nonetheless.

Consequently, it is important to consider what these terms mean and how either scenario would affect the rest of the world.  So let’s examine the differences between a government shutdown and government default.  In analyzing the differences between the two, we will also examine the global consequences that would result in each scenario.

Government Shutdown

In the United States of America, a government shutdown is the process that occurs when congress fails to pass legislation allowing funding to be provided to government operations and government agencies.  While funding is suspended, a literal shutdown occurs.  In other words, while congressional funding approval is in limbo, the related government processes are frozen.

Consequences of Shutdown

As previously listed, some of the consequences of a government shutdown will always be agency specific.  We can use the recent shutdown as an example of how specific agencies and operations were affected.

Closure of National Parks

 In October 2013, the government shutdown led to the temporary closure of national parks.  This did not have a significant impact on the global economy.  Of course, travelers from other nations were not able to visit any national park, and many of them had traveled a great distance; however, the inconveniences caused to individuals and families from foreign countries was not felt on a global scale.

Closure of Government Offices

 As many as one million government employees were put on unpaid leave.  As the length of the shutdown was unknown, traveling overseas was most likely out of the question.  Therefore, as government employees are citizens of the United States and none of them had the opportunity to spend significant amounts of money in foreign countries, the global impact of this consequence was very insignificant.

Stalling of Medical Research Projects

 As a result of the shutdown, medical research projects were temporarily stalled.  This may have had a slight impact on any foreign ties relating to services or supplies tied to the research, but again the global impact of this aspect of the shutdown was very small (if measurable at all).

Change in the Value of the Dollar

 In response to the shutdown, the value of the U.S. dollar fell, which caused some international currency values to rise.  A change in the currency conversion rate was one aspect of the shutdown that did have direct global implications.  Had the shutdown lasted longer, the drop in value of the dollar could have had a major impact on the world economy.   Now that the shutdown is over and the trends have been charted and measured, the value of the dollar did drop significantly as a result of the shutdown.  Yet, this change did not appear to have immediate lasting impact.

Government Default

Government default occurs when the government is unable to fulfill its financial obligations.  In other words, the government cannot pay its bills.

Consequences of Default

A quick Google search will show that the current U.S. national debt is over $17 trillion.  This debt represents financial obligations made up of foreign debts, domestic debts, and debts owed to government programs.  Foreign debts include money borrowed from other countries, foreign banking centers, and oil exporters.  Domestic debts include money owed to individuals, brokers, corporations, mutual funds, private pensions, insurance companies, and even state and local governments.

So what would happen if the U.S. were unable to pay these bills?  Let’s examine some of the immediate consequences:

Changes in Currency Exchange Rates

If the U.S. government were to enter into default, the value of the U.S. dollar would plummet.  Although, this fall in the dollar may have not had a dramatic effect on international currency earlier this year, a government default would have dramatic consequences.  Any situation that causes financial uncertainty will affect the global financial market.  Consequently, the message would be quickly spread around the world to avoid the U.S. dollar.  This means that investors would turn to other currencies for investments.  Predicting which currency would benefit the most from this situation would be dependent upon which nation’s economy appears to be the most profitable and stable at the time of the government default.

Changes in Interest Rates

 Upon government default, U.S. interest rates would skyrocket.   Anyone wishing to borrow money for any reason would see the immediate consequences.  For example, the resultant astronomical interest rate on a home loan or car loan would make it undesirable to purchase either.  This could greatly affect the global economy as many automobiles are made overseas.

Impact on the Credit Market

 The credit market covers companies who look to debt issuance as a means to raise funds.  This market includes junk bonds and investment-grade bonds.  Short-term commercial paper is also included in this market.  Broadly speaking, bonds, notes, and securitized obligations (collateralized debt obligations and mortgage pools) are all encompassed by this market.  In the case of a government default, credit markets would freeze.  This would paralyze any activity related to any of these transactions.

Stock Market Crash

 The stock market is very sensitive to any event that has economic impact.  While many events cause hiccups, a government default would have immediate and lasting consequences on the global stock market.

A Run on the Banks

A bank run occurs when a large number of a bank’s customers rush to withdraw all of their money from the respective bank.  Bank runs are always spurred on by panic and government default would certainly incite panic.  If enough customers try to withdraw their funds from the bank in a short period of time, the bank may enter a position where it is unable to provide withdrawal funds to meet the demands of the run.  When more and more customers rush to the banks, this increases the level of panic not only in the U.S., but also abroad.  Combined with the resultant stock market crash, many customers around the world would most likely panic and rush to secure their money.

Global Recession

The aforementioned consequences would lead to a global recession.  In essence, this means the global economy would slow down.  Individuals and corporations would be less eager to invest and would be hesitant to spend money on any product or service deemed unnecessary for survival until the economic outlook brightened.  This in turn would lead to an increase in unemployment.

Now that we have examined the consequences of a government shutdown or government default, have you considered how these events would impact you directly?  Is all of your money located in one bank?  Would you lose everything in a stock market crash?  Is your wealth dependent on one currency?

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