In a world of economic landmines, it’s a sad commentary that what Federal Reserve officials may fear most is Congress.
Specifically, Republicans now in control of the House of Representatives—and America’s credit rating. These “conservatives” remain hellbent on holding Washington’s debt ceiling hostage as a negotiating tactic. Not raising it would drive the U.S. into its first-ever default.
Asia remembers all too traumatically the last time Republicans played with financial fire. Especially officials in Beijing and Tokyo, who oversee the largest foreign stockpiles of U.S. Treasury securities.
It was back in 2011, when GOP Congress members delayed increasing the borrowing limit so that Washington could pay its bills, including government bond payments. Standard & Poor’s stripped the U.S. of its AAA credit rating. It was a brutal wake-up call for Washington’s biggest financial benefactors, most of which are in Asia.
That PTSD has the Bank of Japan, People’s Bank of China and other leading Asian monetary authorities cutting back on U.S. Treasuries. And here comes the Fed to remind Washington’s top bankers that their trillions of dollars in holdings are increasingly in harm’s way.
At their Jan. 31-Feb. 1 policy meeting, Fed officials aired concerns that political jousting over debt will shake global markets.
“A number of participants stressed that a drawn-out period of negotiations to raise the federal debt limit could pose significant risks to the financial system and the broader economy,” minutes of the meeting said.
All this has Fed Chairman Jerome Powell’s team worried as much, or more, about political sabotage at home as external events in China and Ukraine. Among their biggest concerns are “disruptions in the financial system and broader economy associated with concerns that the statutory debt limit might not be raised in a timely manner.”
They stressed the “importance of the appropriate authorities continuing to address issues related to the resilience of the market.” In other words, the nation that manages the global reserve currency—and a $31.4 trillion debt—risks losing credibility amid rising political instability.
For now, Treasury Secretary Janet Yellen’s team is employing a series of special accounting measures to meet Washington’s obligations. These tactics, though, are only good for a few months.
Economist Shai Akabas at the Bipartisan Policy Center think tank notes that Washington officials “have an opportunity now to inject certainty into the U.S. and global economy by beginning, in earnest, bipartisan negotiations around our nation’s fiscal health and taking action to uphold the full faith and credit of the United States well before the X date.”
The reference here is to the moment when the federal government is forced to renege on debt payments. Congress is setting the U.S. up for quite the own goal—even bigger than in 2011.
In a recent report, Kansas City Fed economists Stefan Jacewitz, W. Blake Marsh and Nicholas Sly argue that “although financial market risks rise when debt ceiling resolutions occur closer to X-dates, resolutions that occur after X-dates likely have the steepest consequences.
Things may be playing out just as Ian Bremmer feared. Each year, the Eurasia Group CEO works up a top-risks list. One of this year’s dire scenarios is how the “Divided States of America” might unnerve markets.
“The 2022 midterm elections,” Bremmer says, “halted the slide toward a constitutional crisis at the next U.S. presidential election as voters rejected virtually all candidates running for state governor or state attorney general who denied or questioned the legitimacy of the 2020 presidential election.”
But, Bremmer warns, “the U.S. remains one of the most politically polarized and dysfunctional of the world’s advanced industrial democracies heading into 2023. Extreme policy divergences between red and blue states will make it harder for U.S. and foreign companies to treat the United States as a single coherent market, despite obvious economic strengths. And the risk of political violence remains high.”
Financial violence, too. President Joe Biden could’ve been speaking for Asian policymakers recently when he said a default would be a “calamity” for the global economy. And a ticking time bomb.
In a report this week, economists at Goldman Sachs said they “expect the debt limit deadline to hit in early to mid-August.” Goldman is hopeful Congress can avoid financial Armageddon. But, they add, political uncertainty over debt payments is the last thing world markets need.
Perhaps House Speaker Kevin McCarthy hasn’t noticed, but the race is on to replace the dollar as the linchpin of global finance. This role bestows on Washington “exorbitant privilege,” as 1960s French Finance Minister Valéry Giscard d’Estaing put it. One that allows the U.S. to live beyond its means, year after year.
For now, at least. In 2011, China’s yuan enjoyed a negligible share of trade. Today, it’s among the top-five currencies and is steadily rising in stature. The PBOC is beating the Fed, BOJ and other Group of Seven authorities to the punch with a central bank digital currency. And China is at the center of a global movement to erode the dollar’s dominance along with Russia, Saudi Arabia and other key oil producers.
In other words, Republicans in Congress can play with fire if they choose. It doesn’t mean Washington’s top bankers here in Asia will watch passively as this financial circus threatens the most important credit rating on earth.