So if the US were to default, it would essentially stop paying the money it owed US Treasury bond holders. A quick refresher: the US government spends more money than it collects in taxes.
So to make up the shortfall, it raises funds by asking investors to buy US Treasury bonds. Investors, such as the Chinese government and pension funds, do this because these bonds are seen as a safe place to invest money.
No one really knows exactly what would happen, but the likelihood is that markets around the world would plunge and global interest rates would rise. This is because if the US government could not repay the money it owed bondholders, the value of the bonds would decrease. And the yield - the return the government pays to an investor - would rise. This is because it would be perceived as a less safe investment.
This would prompt interest rates around the world, which are often tied to those of US Treasuries, to spike. Furthermore, the impact on the US's creditors could be dire. Each day, the US Treasury receives a little over two million bills from various federal agencies. Technically, the payment systems can be turned on - to make payments - or off - but not much else.
That would leave the Bureau of Fiscal Service, which pays money to bondholders. Read next: These 10 states owe late interest on their federal jobless-benefit loans. Follow her on Twitter ARiquier. Home Markets Market Extra. Market Extra What happens if the U.
Last Updated: Oct. ET First Published: Sept. ET By Andrea Riquier. Will the U. Barron's: Rivian Stock Keeps Soaring. Auto Maker After Tesla. Gold scores a 6th straight rise, settles at highest since June Behind highest U. Andrea Riquier. Elon Musk says this is what it will take for Rivian to make it in the EV business. Some countries have adopted it as the official currency, while in others it exists side-by-side with a local currency that is often "pegged" to the dollar to keep its value stable.
In the event that a default drove down the value of the dollar, countries with highly dollarized economies would see the buying power of existing currency stock diminished. Around the world, many cross-border transactions carry requirements that they be settled in U. In ordinary times, this is seen as a practical way to be sure that sudden swings in the value of a local currency don't dramatically disadvantage one party in a transaction that is to be settled in the future.
A sudden and sharp decline in the value of the dollar would mean that individuals and companies anticipating payment on existing contracts in dollars would effectively be receiving less than they had expected for their goods and services. More sophisticated trade contracts may contain anti-default clauses that require agreements to be renegotiated in the event of a default that drives down the value of a reserve currency.
While this would keep both parties to a contract whole, it would also complicate and likely slow down many transactions. One of the economic advantages the United States has long enjoyed is that it is a magnet for global capital. When the global economy is strong, investors seeking growth funnel money to U.
When times are bad, investors seek shelter in U. Either way, global markets are directing capital into the U. But when interest rates go up for the wrong reason — because investors don't trust the U. The result is that to some degree, investors seeking shelter would be more cautious about assuming that Treasury securities are the go-to investment to protect the value of their assets. The logical move would be for them to begin directing at least some of their investments to securities issued by other governments and denominated in different currencies.
A side effect of those new capital flows could be a challenge to the dollar as the world's "reserve currency. A reserve currency is money held by a country's central bank and large financial institutions in order to facilitate global trade for domestic companies, to meet international debt obligations, and to influence domestic currency exchange rates, among other reasons.
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