China and other countries that now hold about 50 percent of all U.S. Treasury securities could start dumping them, further pushing up interest rates and swelling the national debt. It would be a vicious cycle of higher and higher interest rates and more and more debt.
The United States has never defaulted on its debt and Democrats and Republicans say they don’t want it to happen now. But with partisan acrimony running at fever pitch, and Democrats and Republicans so far apart on how to tame the deficit, the unthinkable is suddenly being pondered.
“It’s another game of chicken. And this time there are Mack trucks going at each other, not bumper cars. This is a biggie,” said American University political scientist.” James Thurber American University
The government now borrows about 42 cents of every dollar it spends. Imagine that one day soon, the borrowing slams up against the current debt limit ceiling of $14.3 trillion and Congress fails to raise it. The damage would ripple across the entire economy, eventually affecting nearly every American, and rocking global markets in the process.
A default would come if the government actually failed to fulfill a financial obligation, including repaying a loan or interest on that loan.
The government borrows mostly by selling bonds to individuals and governments, with a promise to pay back the amount of the bond in a certain time period and agreeing to pay regular interest on that bond in the meantime. Source: CNBC (1)
Buying more debt is the solution?
Unless the US is able to persuade foreign investors to buy more debt, it WILL be forced to print money (QE 2.5 and 3.0) which will further erode the USD. There is no way any American politician is going to choose deflation over inflation – just for optics alone, an inflationary environment can be massaged to look like real growth – after all, GDP will rise in a high-inflation environment, even if purchasing power is being lost.
One way to think of it (a very simple way, actually) is to take the GDP growth per annum and subtract the REAL inflation rate from it. Then you derive the actual economic growth amount.
Currently it is in negative territory for the US (and probably Canada as well). Translated into another metric, it means that, without the artificial injections of printed money into the financial system, we would be in a total depression worse than the 30’s right now. With them, we can mask the recession thru inflation. Either way you slice it, it ain’t lookin’ good.
People assume that if the US currency falls off the cliff, Canada and others will need to follow in order that we can still export to them. This assumes that American buying goods from Canada and others will be able to use the US currency to pay for them. The caveat is, if and when the US dollar ceases to be the reserve currency of the world, they will need to deal with us and everyone else on our terms and currency. Then watch the sparks fly and squawking start. This will be called inflation — US style — read hyperinflation.
On the other vein, during hyperinflation, interest rates typically rise to double digits per month. Inflationists find it difficult to reconcile the Fed’s massive balance sheet growth since August 2008 with short term rates at zero. But deflationists understand why investors are willing to hold government paper at such low returns. You can read more about this argument here.