U.S. Debt Crisis: Government Shutdown Looms, $1 Trillion Coin to China?

• 2024-10-02
• News

U.S. Treasury Secretary Janet Yellen sent a letter to Congress on May 1st, warning that if the debt ceiling is not raised or suspended, the U.S. government may face bankruptcy on June 1st. Although the U.S. debt crisis has a long history, this is the first time a specific date for default has been mentioned. President Biden, in turn, has convened a meeting with key U.S. politicians scheduled for this month on the 9th to discuss the issue of the debt ceiling.

If Congress does not raise the debt ceiling, can the U.S. continue to print money? In the face of such a scenario, is it still effective for the U.S. to print money without restraint? As the world's largest debtor nation, with China being the second-largest creditor of the U.S., how should it face the risk of the dollar going bankrupt?

The U.S. government faces bankruptcy.

The issue of the U.S. debt crisis has a long history, and the solution is nothing more than raising or suspending the debt ceiling.

However, with the continuous explosions in the U.S. domestic banking industry and the crisis of dollar credit, the political deadlock caused by the dollar debt between the two parties in the U.S., the attitude of the U.S. government, led by Biden, is particularly important in the face of this round of debt default risks.

As early as January of this year, the U.S. debt had reached the debt ceiling of $31.4 trillion. The White House and the House of Representatives were deadlocked, each making concessions, and reached an agreement to raise the debt ceiling in the days leading up to the deadline for default, which seems to have become the "duet" played by the two parties in the U.S. when dealing with debt defaults.

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The reasons for debt default, in addition to the original consumption concepts in the U.S., are also exacerbated by the complex domestic and international economic environment, leading to the occurrence of the debt crisis.

As the world's most developed economic entity, relying on dollar hegemony, borrowing and spending has become a model for U.S. economic development.

The White House's large-scale spending will inevitably come at a cost.In the United States, since Trump's administration, domestic tax cuts have been implemented. The Biden government, facing the pandemic, has been printing money on a large scale and distributing it to the public for consumption. With increased government spending and reduced tax revenues, the domestic finances are facing a crisis.

Abroad, the United States incurs substantial annual military expenditures, so-called "military aid expenditures" to other countries. For example, in the Russia-Ukraine conflict, U.S. aid to Ukraine has reached $36 billion.

Data shows that in 2022, U.S. fiscal expenditures were approximately $6.272 trillion, while fiscal revenues were only about $4.896 trillion.

No one will foot the bill for these expenditures. This economic operation model, which spends beyond its means, inevitably requires the United States to issue a large amount of government debt to raise funds.

When the debt scale reaches its limit, the only way out is to raise or suspend the debt ceiling. However, the White House and the House of Representatives are at odds with each other, so every time the debt ceiling deadline approaches, the government is particularly troubled.

The U.S. House of Representatives unilaterally proposed a bill to raise the U.S. debt ceiling by $1.5 trillion, while demanding that the federal government cut spending by $4.8 trillion over ten years.

For the White House, this is obviously too harsh. They do not want to bear the risk of debt default and do not want to reduce spending. It is clearly a pipe dream to want to have both fish and bear's paw.

Nobel Prize winner Paul Krugman suggested that the United States could mint $1 trillion in platinum coins and deposit them into the Federal Reserve. In this way, it would neither cause a debt default nor inflation. However, would the U.S. Treasury, the Federal Reserve, or even the courts agree with such a practice?

It's not just the U.S. economic development model. The downward trend of the U.S. domestic economy has also accelerated the risk of U.S. debt default.

The decline in the global credit of the U.S. dollar has become a trend, with countries actively de-dollarizing. The proportion of dollar settlements in global foreign trade has fallen from a peak of 71% to 41.1% in February of this year.The situation within the United States is also not optimistic, as six states in the country are seeking to de-dollarize, attempting to use gold and silver as new forms of currency.

On May 1st, the First Republic Bank of the United States announced bankruptcy, with its assets sold to JPMorgan Chase. The collapse of Silicon Valley Bank has already set off a chain reaction, with numerous banks in the United States closing one after another, indicating that the U.S. banking industry is clearly facing a crisis.

The banking industry holds an important position in the financial system, and a large-scale bankruptcy in the banking sector will inevitably cause turmoil in the financial markets.

The floating losses in U.S. Treasury bonds triggered by the Federal Reserve's interest rate hikes, the chaos in the financial markets triggered by the successive failures of the banking industry, and the credit risks of the dollar in the global market are all like straws pressing on the "camel" that is the United States, and it remains to be seen whether a debt default will be the last straw.

Consequences of Debt Default

The U.S. debt issue has a long history and can only be resolved by borrowing new debt to repay old debt, which has also led to a trend of rising U.S. debt year by year. Even if Congress passes a proposal to raise the debt ceiling, the United States is merely "robbing Peter to pay Paul," unable to fundamentally resolve the debt crisis.

Furthermore, the U.S. debt crisis is an important bargaining chip in the political rivalry between the two parties. President Biden previously announced his participation in the 2024 election. Regardless of which party wins the election, in the four-year cycle of the "donkey and elephant contest," the debt crisis is a sharp knife, stabbing at the pain point of the incumbent.

Therefore, the root cause of the debt crisis will not be easily resolved, and in today's economic context, there is even a risk of a financial explosion.

If within the expected time frame, the Biden administration cannot reach an effective agreement and the U.S. debt crisis cannot be resolved, it will have an impact both domestically and internationally in the United States.The first and foremost concern is that the U.S. government may face bankruptcy, with the White House's debt outstripping its income. If the U.S. government cannot change its habit of spending lavishly, and it is unable to levy substantial taxes in the short term, the government is likely to face collapse.

With the U.S. government facing bankruptcy, a series of domestic welfare benefits will be affected, including medical insurance, pension payments, and unemployment relief, all of which are closely related to the lives of the public. Reducing welfare benefits will undoubtedly lead to public dissatisfaction with the current government.

The industry generally predicts that the U.S. economy will go into recession, and a U.S. debt default is likely to accelerate the arrival of this recession. A recession in the U.S. economy will lead to massive job losses, and a large number of unemployed people will cause social instability.

Debt default will not only affect the United States domestically but also cause shocks in the international market.

As the world's largest debtor nation, a debt default by the United States will inevitably affect its creditors.

As the world's largest importer and second-largest exporter, a debt default by the United States will inevitably affect global foreign trade. Countries holding U.S. dollar debt will suffer trillions of dollars in losses, with consequences that are hard to imagine.

China, as the second-largest creditor nation of the United States, will see some of its foreign trade industries suffer a significant blow, and may even face bankruptcy if the U.S. defaults on its debt. Other countries that hold U.S. debt will also be affected in their foreign trade.

As the world's largest financial market, debt default is difficult to eradicate. Once it occurs, the domestic financial market will be in turmoil, the international financial system will inevitably be hit, and it may also lead to the restructuring of the international financial market.

For example, in 1971, a U.S. debt default led to the collapse of the Bretton Woods system, and then the dollar was pegged to oil, forming the petrodollar hegemony.

The U.S. Treasury Secretary has repeatedly warned Congress about the potential risk of debt default. The two major U.S. political parties, disregarding the national interest, show a clear downward trend in the U.S. economy, and it seems that the collapse of the dollar is not far off.As the second-largest creditor nation to the United States, how should China respond to the potential crisis that may be approaching?

How China Should Respond to a U.S. Debt Default

If the U.S. government insists on printing dollars to repay its creditors, this is obviously not feasible.

Due to the continuous issuance of currency by the Biden administration in the early stages, severe inflation has been caused domestically after the end of the pandemic. Now, the Federal Reserve's continuous interest rate hikes are aimed at reducing the circulation of dollars. Therefore, it is clearly not viable for the United States to continue repaying its debts by printing more dollars.

The federal government could mint a $1 trillion platinum coin to repay the debt, using this method to settle its obligations. This idea is not necessarily out of the question, but would the U.S. Treasury Department allow it?

However, some economists worry that this could exacerbate inflation within the United States. Moreover, the Biden administration is attempting to seek Congress's unconditional increase in the debt ceiling. The minting of a $1 trillion platinum coin seems rather unrealistic.

At present, as the second-largest creditor nation to the United States, China's response to the potential U.S. debt crisis would essentially involve selling U.S. Treasury bonds, stockpiling gold, and accelerating the establishment of a new currency system by BRICS countries primarily based on gold.

As of February this year, China held $848.8 billion in U.S. Treasury bonds, down from $859.4 billion in January of this year, reaching the lowest point in recent years.

Currently, countries around the world generally hold a negative view of the dollar. For now, the trend of selling U.S. Treasury bonds, led by Japan and China, is further strengthening, leading a global trend of selling U.S. Treasury bonds.Not only are countries like Japan and China, as the largest holders of U.S. debt, selling off their holdings, but even the Federal Reserve itself is "undermining its own foundation."

Affected by domestic interest rate hikes in the United States, the Federal Reserve has also begun to reduce its balance sheet. Changes in the balance sheet require the Fed to sell off the bonds that have accumulated in recent years. The domestic banking industry has seen frequent explosions, and bank bonds have also been massively sold off.

The dollar is losing trust, and reserving gold is of utmost importance.

Central banks around the world are simultaneously increasing their gold reserves. In 2022, central banks increased their gold holdings by 1135.7 tons. The "central mother" has also been continuously increasing gold reserves in recent months. As of the first quarter, China's gold reserves only account for 3.9% of China's foreign exchange reserves. This proportion obviously has a lot of room for development.

The general increase in gold reserves also indirectly shows that countries around the world generally do not have high hopes for the dollar. The dollar itself is also a commodity. When this commodity no longer has value, countries need to find a substitute for it. Gold itself has inherent value.

At present, BRICS countries are also considering creating a new currency to deal with dollar debt. However, the circulation and effectiveness of the new currency are both greatly tested, and the stability of the original currency becomes more important.

Whether the BRICS countries want to establish a new single currency like the euro for settlement among countries, or a new trade method linked to precious metals such as gold and rare earths, or to use the currency of one of the member countries, these methods are all potential concerns about the dollar's trust crisis, with both worries and challenges.

For the United States, the domestic and international economic situation is turbulent, and the dollar may go bankrupt in the near future. The domestic and international economic situation seems to be at the end of its tether. Once the United States goes bankrupt, it may take many "desperate" actions. We need to be prepared for this.

Faced with the dollar's trust crisis, for China, it is both an opportunity and a challenge. How to deal with the changes in the international economic situation after the dollar goes bankrupt, and how to quickly internationalize the renminbi after the dollar goes bankrupt.