The American media is abuzz with stories of doom and gloom as tensions mount over stalled efforts to raise the U.S. debt ceiling. Europe, meanwhile, has its own debt woes, with mounting fears that a default in Greece could spill over into Ireland, Portugal and Spain. So far, however, there has been relatively little discussion about what these twin crises would mean for the 5 billion people living in developing countries. Sadly, those with the least influence over the issue could pay the highest price.
On this week’s Wonkcast, I invite senior CGD fellow and global finance expert Liliana Rojas-Suarez to explain why it’s important to the rest of the world that Europe and the United States put their financial affairs in order. The showdown in the U.S. is especially worrying, Liliana says, because of the U.S. dollar’s role as the international reserve currency.
We begin by discussing the many channels through which a U.S. default could hit people in the developing world. Liliana tells me that speculation and uncertainty over whether the U.S. will meet its obligations raises the risk premium and lowers the value of U.S. Treasuries. This implies an increase in the interest rates that the U.S. has to pay to roll-over its outstanding debt or to issue new debt. A U.S. default could spell disaster for developing countries, whose foreign reserves are held mostly in U.S. T-bills and whose economies are dangerously dependent on U.S. capital markets.
“To put it simply, a default could mean another global crisis,” warns Liliana. “The reserve currency of the world [the dollar] will no longer be reliable, but the entire world is currently functioning around that currency. The financial system is very nervous right now and there would be panic.”
Liliana’s debt default scenario is grim indeed. For developing countries, higher interests rates will mean less poverty-reducing economic growth and the increase in government financing costs will mean fewer anti-poverty programs. For households, higher interest rates and a reduction in the production of goods and services will mean higher prices.
“Furthermore, you have to view these events in the context of the 2008 financial crisis which is ongoing,” says Liliana. “As long as the U.S. fails to solve the mortgage crisis they are not going to be able to generate long term growth. Combine low growth rates with less demand in the U.S. and the developing world is in a lot of trouble.”
As we end, I ask Liliana if she thinks U.S. will can reach a last-minute to forestall a meltdown. Thankfully she believes so, but she tempers her optimism by reminding me that some damage has already been done.
“Even if the ceiling is raised, the U.S. is now on a watch status from the rating agencies,” cautions Liliana. “Even if they solve the debt ceiling problem they still have to solve the debt problem. To do that they need political will, but right now, the U.S. is behaving so poorly in terms of political will it’s shameful.”
To hear more on the U.S. debt crisis, listen to the Wonkcast. If you have iTunes, you can subscribe to get new episodes delivered straight to your computer every week. My thanks to Will McKitterick for his production assistance on the Wonkcast recording and for assistance in drafting this blog post.
