The world is in need of a wake-up call after the US default on its debt

Interest rates will skyrocket. Stock and bond markets are going to crash. The global financial system will be in turmoil as investors rush to find safe assets.

Every day, the clock ticks closer to the deadline of a deal between Congress and President Joe Biden on raising the debt ceiling in the United States.

According to the majority of experts, if a deal doesn’t get done by June 1, there will be a global economic catastrophe of epic proportions, as the US defaults its debts.

This outcome will not be a pleasant one. There will be chaos for a few days if it does happen. A American default is exactly what the world needs.

In reality, over the past 20 years we have piled up debts and deficits like they would never be repaid. This has led to inflation, inflated asset prices, and a slew of unproductive investments. It’s also forced governments into big spending programs that they can’t afford.

A deal will be made at the last moment to prevent the US from defaulting. It might not be the best thing for us all if we defaulted.

The deadline is less than two months away. The US is technically in default on June 1 unless Congress and the President can reach an agreement to raise the debt ceiling.

Republicans are not willing to raise it above the current $31.3 Trillion (£25.1 Trillion) unless White House agrees on controlling its spending and easing the tax burden. Unsurprisingly, Democrats and President Obama think that another few hundred billion dollars should be brushed aside as if they didn’t exist. Next week we will see how things unfold.

Everyone agrees on one thing. A default on the debt would be disastrous for the global economic system. Jeremy Hunt, Chancellor of the United Kingdom, warned that the impact of a default would be “absolutely disastrous”. The White House Council of Economic Advisers predicted that it would cause a deep recession with a 6.1pc fall in GDP alone in the US.

It would be a bad thing. You can easily understand why. The American government would be forced to stop paying its bills as it briefly did in similar standoffs during Barack Obama’s presidency. The bond market would be in chaos, as Treasury bills, which are the benchmark by which all other bonds are priced, were in freefall. Investors would also be trying to determine which government was next. Everyone wants to avoid such chaos.

A default by the United States could be the jolt the global economy desperately needs.

This would serve as a strong reminder that the total of borrowing cannot continue to rise forever with no consequences.

IMF figures show that global debt is now $300 trillion, up from $200 trillion when the decade began. By the end of this decade, the total debt will reach $400 trillion.

There has been a huge increase in the state debt. Japan’s debt to GDP ratio has reached a staggering 225pc. Italy’s debt-to-GDP ratio is 140pc and France’s is 111pc. The UK, which has been no slouch in borrowing money for the past few years, just passed 100pc. This was previously considered the upper limit without triggering the collapse of confidence.

Not just governments. The borrowing of money by corporations has been massive. Companies around the globe owe a total of $87 trillion or 97pc global GDP. Consumers have borrowed just as much. We are literally drowning under debt.

All around us, we can see its consequences. The US has seen a rise in inflation, which reached close to 10% at its highest point. In the UK, it was also near that level.

It is not surprising that the prices are increasing. Although rising interest rates may help to control this, we also need to reduce our debt.

It has also stoked asset prices by creating mini-bubbles, from internet stocks to cryptocurrencies to stocks and bonds, property, or even stocks.

Thirdly, it’s kept dead companies alive and poured money into industries with little chance of a proper return.

It has also allowed the government’s expansion to be fueled by borrowed money, rather than raising taxes. This is a result of their unwillingness to meet unrealistic demands for more spending from their voters.

All that borrowing has to stop at some point. A default by the US Government would be a bad shock.

Financial markets would be in a panic. Bonds would crash. Stock markets would collapse. And, for many federal employees, this would cause real hardship.

It would not last forever. In a matter of weeks, a compromise will be reached to allow the US continue borrowing. It would send a dramatic and symbolic message to the world economy.

One day, the party will have to end. We cannot keep borrowing money forever. The books will eventually need to be balanced again. Even if the pain is temporary, starting at the beginning of June could be a good start.

Post Disclaimer

The following content has been published by Stockmark.IT. All information utilised in the creation of this communication has been gathered from publicly available sources that we consider reliable. Nevertheless, we cannot guarantee the accuracy or completeness of this communication.

This communication is intended solely for informational purposes and should not be construed as an offer, recommendation, solicitation, inducement, or invitation by or on behalf of the Company or any affiliates to engage in any investment activities. The opinions and views expressed by the authors are their own and do not necessarily reflect those of the Company, its affiliates, or any other third party.

The services and products mentioned in this communication may not be suitable for all recipients, by continuing to read this website and its content you agree to the terms of this disclaimer.