What if the USA were to default on its debts?
Recent talk has been harboring amidst the stalemate between the Democrats and Republicans on passing a budget deal. No one knows what a United States in bankruptcy would look like since every government up to the contemporary one have passed a debt ceiling to let the United States fulfill its fiscal obligations. Though much political party fervor revolves around the issue in an ideological storm, the effects of an American default can further be scrutinized through a discussion of Argentina’s economic woes in the late 1990s and early 2000s. Argentina, so far, has been the largest sovereign nation to undergo a default. If the United States is to be next, we should understand any repercussions and even if we should allow a default.
Background
Coming into 1990, Argentina was already facing a heavy round of hyperinflation. The initial measures of the early 1990s (administered by Domingo Cavallo) included a fixed value of the Argentinean currency to the American dollar (at 10,000 Argentine pesos per US Dollar). The initiative was further solidified by La Ley de Convertibilidad in which the Argentine Peso was restored on a fixed rate to the US Dollar. The effects were drastic: inflation dropped and prices were insured while the quality of life amongst Argentineans improved.
The Problems
The fixed rate made imports very cheap. In response, the government increased imports to the point that Argentinean industry decreased to cause higher unemployment. Government spending continued to rise along with internal corruption in the government. The main problem, in my opinion, was Argentina’s dependence on other nations: The peso had a fixed rate on the dollar (so the peso would do well as long as the dollar did well in the market and vice versa) and Argentina could not depend on its own industries since it invested so much in imports (Brazil and Mexico were Argentina’s two biggest trading partners). The problem with having a fixed exchange rate is that the country has no control over the money in circulation. For example, in the United States, if inflation is high in the economy the government can essentially buy the money back to add value to the money in circulation. Conversely, if deflation is rampant, then the government can attribute more money into circulation. The treasury department has some control over the economy. The main argument against a fixed exchange rate is the lack of control of a country’s economy (Argentina had a fixed exchange rate, thus it had no control of its money). Unfortunately for the Argentinean government, the American dollar was strong in the late 1990s, so that made the peso strong as well in as time when Brazil’s currency fell in value. Thus, Argentinean exporters had a difficult time exporting goods to one of its main trading partners. With high unemployment and less revenue the future of the Argentinean economy looked grim. By December 2001, street protests were common, the president resigned his position, and Argentina defaulted. The Peso immediately fell in value.
The United States
Obviously, the case between the United States and Argentina is very different. First of all, the United States does not operate on a fixed rate. So, the Federal Reserve can control the circulation of money by buying and selling bonds when the situation is appropriate. Second of all, an American default depends on the decision of the government, and it is not an inevitable consequence of bad economic policies. Now, let’s look at some of the consequences of a default for the United States. If the United States were to default, the value of the American dollar would drop drastically. Then, interest rates would increase, making future borrowing more expensive for the United States in the long run. Also, exports would become cheaper for other countries while imports would become more expensive. But, one must also take a perspective in international relations. Most countries would not be positive to the fact that their assets in American dollars all of a sudden lost a tremendous amount of value. Not only would countries be weary of conducting future business with the United States (seeing that the default was not necessary in the first place), but Americans would experience two economic crisis within five years. I do not believe that the world, nor Americans, is prepared for the effects of the default of the world’s biggest economy. We must withhold the needs of the country before the needs of any political party.
- WSQ
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