The United States, i.e. the world’s leading economic power, may be threatened with insolvency as early as next week.
This is because no agreement has been reached on raising the country’s debt ceiling. The ceiling has been raised dozens of times in the past, but now the administration is in a particularly tight spot. There are political disagreements on the debt level and spending cuts on the way to an agreement.
The Treasury minister Janet Yellen has said that the negotiations should be decided before the beginning of June, i.e. next Wednesday. If an agreement is not reached by then, the United States may not be able to meet its payment obligations.
A US default would be unprecedented, and the threat of it is unnerving markets around the world. On Wednesday, credit rating agency Fitch announced that it had put the US’s top credit rating on watch in case it needs to be downgraded.
In this article, we gathered four key questions about possible insolvency and its effects on the world economy and Finland.
1. How has the market reacted to the prolongation of the negotiations?
The market has become nervous and the main stock indices have been falling. However, there is no panic.
Analyst at banking group Danske Bank Antti Ilvonen estimates that prolonging the debt ceiling negotiations has weakened investors’ willingness to take risks. Particular nervousness can be seen in the interest rates of US government bonds maturing at the beginning of June.
Chief strategist at asset management company Evli Valtteri Ahti however, emphasizes that the fluctuation has not been very large or extensive so far. For example, the S&P 500, which follows the largest US companies, has fallen by only about one percent in the last five days.
However, the situation may change and nervousness may increase significantly if no agreement is reached in the negotiations by the beginning of the week. In that case, stock prices would most likely turn to a decline more widely – also in Finland.
One factor of uncertainty is related to the so-called x-day, that is, the date when the US money will actually run out. According to Ahti, the market does not fully believe in Yellen’s estimate for Wednesday of next week, but it is partly considered a negotiation tactic.
– Many investment banks expect that the deadline will actually be June 8 or 9, but it is difficult to estimate. In practice, the debt limit of the United States was exceeded already in January, but so far we have managed with various special arrangements.
2. What would be the economic effects of a US default?
The insolvency of the United States would be a serious issue for the world economy, and it would also be felt in Finland. However, it is difficult to assess the effects of insolvency, as the situation would be unprecedented, according to analysts interviewed by .
In practice, default would mean that the US Treasury would have to decide who they pay their fees to and who they don’t. In this case, panic would arise, mistrust would increase and the United States and, by extension, the entire world economy could sink into recession, Ahti estimates.
– In this situation, the US central bank FED would probably start to protect the market, buy bonds, cut interest rates and thus try to break the cycle.
A US default would be a crazy situation, because US bonds are considered the most reliable in the world. If the country failed to manage its payments, market interest rates would probably rise sharply in different parts of the world, estimates Antti Ilvonen.
As a result, economic growth would shrink worldwide and would also be felt in Finland.
– The economic outlook is already weak here in Finland, and it would not be necessary for such a political shock to further weaken the outlook, says Ilvonen.
3. How likely can insolvency be considered?
Not very likely.
Raising the debt ceiling has been a political bone of contention in the past, and it is not unheard of for negotiations to drag on to the last few meters. The situation is therefore not exceptional in that sense.
– After the financial crisis of 2008 and the increasing indebtedness of the United States, the matter has become politicized. Now is another more difficult year. That was also the case in 2011, says Valtteri Ahti of Evlin.
Analysts consider it unlikely that a decision on the debt ceiling would not be reached. None of the budget issues on the negotiating table are so important that the Republicans or Democrats would want to push the United States into insolvency because of it, says Antti Ilvonen.
The problem, however, is that it is not known exactly when the money will run out, and therefore the risk of human error increases all the time, according to Ilvonen, and suddenly you may be insolvent.
– Here we are now playing with fire in terms of how low the politicians dare to let the cash level go.
4. How would the agreement on raising the debt ceiling affect the economy?
It is likely that the stock market would pick up once the worries subsided, but the effects would hardly be far-reaching.
However, according to Ahti, the recovery of the stock market would require that they have time to fall properly before the agreement. Now this has not happened yet.
Dansken Ilvonen estimates that the agreement would probably not have very far-reaching effects, since the assumption is that an agreement will be created.
– Then the market’s attention would focus again on weighing the themes that have been weighted here before, i.e. inflation, interest rates and the threat of recession. They are not very positive either, so you will hardly see any crazy rally.
Raising the debt ceiling was discussed in the morning of on Wednesday, May 24.
You can discuss the topic until 23:00 on May 26.