The World Bank and International Monetary Foundation (IMF) are holding their 2013 meeting in D.C. this week, and the fiscal fights taking place inside the U.S. are the main topic of conversation. Each year, finance ministers and central bank leaders hold an annual meeting to discuss the global economy and any risks to it. This year, the potential for a U.S. default sits atop the list of risks.
While a government shutdown primarily affects the U.S. economy, a default could cripple the entire global marketplace. The dollar is the world's reserve currency. Foreign governments own significant quantities of it, and most international transactions are completed in dollars. This is because the U.S. debt is considered 100% secure. Since the United States has the ability to print its own currency, investors have assumed, up until recently, that the chance of the U.S. defaulting on its obligations is 0%. That assumption is now being called into question amidst domestic political fighting.
Republicans are refusing to raise the debt ceiling without a concession from President Obama and Democrats. When the U.S. hits that ceiling on Oct. 17, it will be unable to borrow more money and will not have enough revenue to fund all of its expenses. Many policymakers are calling for the Treasury Department to prioritize interest payments so the U.S. does not default on its payments. Some economists are calling for the president to raise the debt ceiling unilaterally. Either way, the U.S. is quickly hurtling towards the deadline and investors are becoming nervous.
If the U.S. does breach the debt ceiling, foreign creditors must reevaluate their use of the dollar as the world's reserve currency. China and Japan, which own trillions of dollars of U.S. treasuries, have both said as much. Foreign investors will charge higher interest rates on U.S. debt to make up for this new credit risk, which could cause major swings in global currency markets. Altogether, breaching the debt ceiling, even if the Department of the U.S. Treasury finds a way to prioritize interest payments, it would likely create a massive international financial crisis.
That's why the U.S. will face intense scrutiny from foreign finance ministers this week with everyone hoping that the two political parties negotiate a solution immediately. However, President Obama and Treasury Secretary Jack Lew should not relent on their pledge not to negotiate with Republicans over the debt limit. A default now would be a disaster, but avoiding a default via negotiations that set a precedent for debt-ceiling hostage-taking would be even worse. It would set the standard that a minority political party could use the debt limit to extort policy concessions from the president. That is not acceptable.
If that happened, every time the U.S. neared the debt limit, one party would threaten an international financial crisis if the party in power didn't meet its demands. This perpetual hostage-taking would consistently wreak havoc on the global economy. Undoubtedly, the U.S. would default in the future as the two parties will not always come to an acceptable solution. IMF and World Bank leaders may not understand that negotiating over the debt limit would ensure future financial crises, but Obama does. He must stand firm in his refusal to negotiate.