The United States and our allies won World War II because of overwhelming economic power. The Allies outproduced Germany and Japan by more than six to one after 1942, and this advantage would prove too much to withstand. We won the peace that followed through the same economic power — rebuilding through the Marshall Plan and incorporating Germany and Japan into a Western economic order where the U.S. dollar was the reserve currency, and every other country pegged their currencies to ours.
In the early 1970s, this fixed exchange rate system was dropped and financial flows began to grow, but the power of the U.S. dollar has only increased in modern globalized financial markets. Why? Imagine you are an investor in Rio de Janeiro. Knowing that Brazil has had eight currencies since 1942, do you want to hold your assets in Brazilian currency?
The same holds true for investors from many countries; local currencies simply lack the stability and clout of the U.S. dollar. Investors thus want dollars, but not usually in cash. They much prefer Treasury bonds, which pay a fixed return in dollars.
Because of the unique respect and demand for Treasury bonds, the U.S. government is able to borrow cheaply on global markets, a privilege most countries are not afforded. And we have consistently run deficits, which make domestic budgeting less burdensome while supplying global markets with Treasury bonds.
To understand how powerful this is, look simply at the repeated efforts undertaken by Russia, China and other rivals to undermine or replace the dollar globally, or note how in any major economic crisis (2008 or 2020) U.S. borrowing costs decrease because global investors seek the safety of Treasury bonds.
That brings us to the debt ceiling. House Republicans have some leverage — if Congress does not raise the debt ceiling, then the Biden administration cannot keep issuing Treasury bonds and paying the nation’s bills without violating the law. Republicans have thus taken a hard position that Democrats must agree to drastic cuts in order to raise the ceiling. But how far does this leverage go?
Consider what happens if the debt ceiling is not raised. The U.S. Treasury Department will be in a legal bind because of conflicting directives from Congress: On the one hand are obligations that must be paid and require funding, on the other hand is the debt ceiling that prevents additional funds from being raised. The administration then faces a choice: Does it honor the debt ceiling and default on U.S. obligations? Or does it continue to fund such obligations and declare the debt ceiling null and void?
It is not a difficult choice. Defaulting both violates the law and drastically changes global finance, leading to a major recession in the U.S. and globally. In the aftermath, the U.S. dollar would simply never recover its standing, meaning that U.S. borrowing would become more expensive forever. And such a default would certainly be litigated in multiple ways, leading to further market and political instability. Defaulting on debt we can afford to pay is the most fiscally irresponsible choice imaginable and would do irreparable harm to the country.
The Biden administration will then choose the other option and breach the debt ceiling, citing the best legal justification their lawyers can craft. That too will cause instability and be litigated, but on better political and economic terms for the administration. The Republicans’ option in this scenario would be suing to insist that the U.S. government default because the debt ceiling must be honored.
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In the midst of political and economic uncertainty, does the Republican Party really want to go to the Supreme Court and argue it should be worse? Who will make the case for destroying the unique value of the U.S. dollar in the world economy? Who will argue that we should willingly abdicate our position as the world’s leading economy with the most stable currency? If we find ourselves in this situation, it will become painfully clear who truly values the United States, our history and our economic strength.
Republicans actually have very little leverage here. A simple deal to continue the budget status quo would be acceptable to Democrats, but House Speaker Kevin McCarthy’s majority depends on a caucus of extremists who will not agree. Because Congress is this dysfunctional, we’ll either see a debt ceiling increase come from a combination of Democrats and a few responsible Republicans or the deadline will come, the ceiling will be hit, and the Biden administration will pay our debts anyway. The second outcome will damage the country; however, it is far better than the alternative of default. It will be a self-inflicted economic wound that should embarrass us all. Until we elect serious, responsible representatives in the House we cannot expect any better.
Alan Green is associate professor of economics and chairperson of the economics department at Stetson University.