(Frank Franklin/AP)
This is a guest post by Stephen B. Kaplan, assistant professor of political science and international affairs at George Washington University. He writes about the politics of global finance and development and is the author of Globalization and Austerity Politics in Latin America.
The risk of a near-term U.S. default appears to have dissipated following Thursday’s congressional agreement to reopen the government and extend its borrowing authority into February. Short-term bond yields, which move inversely to prices, are once again trading close to the Federal Reserve’s near-zero interest rate target. The White House hailed the pact, which it said would “remove the threat of economic brinkmanship.”
A credible commitment to debt repayment is the cornerstone of a healthy relationship between creditors and debtors. Even during the 2008-2009 recession and financial crisis, global investors rarely doubted the full faith and credit of the U.S. government. This allowed the U.S. to finance its obligations cheaply over a long-term horizon, separating it from other highly indebted countries. These other countries have often struggled to stay afloat, given the relatively short-term horizon provided by international investors. Concerned that these governments might default, investors have often issued debt with maturities of less than one year. As I show in my book, many developing countries have built institutions, such as currency boards, fiscal rules, inflation targeting, and independent central banks, in part to convince creditors that default was unlikely. This has worked, providing economic stability but often at the cost of lower growth and employment and sometimes even social instability.
Repeated budgetary stalemates have started to make the U.S. look like a turkey too. Few creditors doubt the U.S.’s capacity to pay its debt, but the political theater surrounding the debt ceiling has clouded market perceptions about the U.S.’s willingness to pay its debt. Most recently, Fitch Ratings expressed concern about “the prolonged negotiations over raising the debt ceiling,” placing the U.S. on watch for a potential credit downgrade.
Over the last two years, however, these governments have become increasingly skeptical about the U.S.’s fiscal governance. During the first debt ceiling showdown in 2011, China expressed its “hope that the U.S. government adopts responsible and measures to guarantee the interests of investors.” More recently, however, China’s sentiments have become far less mild. China’s state newspaper, Xinhua, said that it was time to “start considering building a de-Americanized world” that would include the “introduction of a new international reserve currency.” And notwithstanding the budget deal, China’s largest credit rating agency, Dagong Global, downgraded U.S. debt.
To mitigate this growing global scrutiny and rising interest rate premium, the U.S. should scrap its debt ceiling. It serves such little economic purpose that most countries do not have it, and in the U.S. it often has been used as a political tool, allowing the opposition party to signal its discontent with deficit spending. In 2006, for instance, then Sen. Barack Obama opposed raising the debt limit saying, “America has a debt problem and a failure of leadership.”