Ongoing fiscal dysfunction costs US international trust

Even if the US government manages to raise the debt ceiling by the October 17 deadline, the crisis has already resulted in the country’s reputation being severely tarnished, according to British economist Neil Mackinnon.

In his interview with RT, Mackinnon, who is also a former UK treasury official, said the global economy is witnessing a major shift with emerging markets gradually growing in importance and outweighing Western models. He believes the current debt ceiling crisis in the US will only contribute to the process. 

The fact that fiscal crises have become a regular thing for the US will, according to the economist, eventually lead to the dollar losing its role as the global reserve currency and the world moving to a multipolar currency system.

RT:Just how bad could this default be?

Neil Mackinnon: Well, I think it could have quite considerable negative implications, if we do get a technical default. Remember that this is a technical default, America being a sovereign country which prints its own money and issues its own debt. So the idea of America going bankrupt is incorrect. But a technical default can happen if America misses payments on bondholders and if that happens, then you could easily see the rating agencies downgrading America’s credit and that has lots of ripple effects, lots of knock-on effects in terms of banks which got exposure to US treasuries, the money market funds, mutual funds, and it could be very serious indeed. Over and above, I think, it’s the loss of confidence that the technical default would lead to in the international investment community.

RT:China and Japan hold more than 2 trillion dollars in US treasuries. Why are investors still choosing America over any other country?

NM: The US treasury market, the government bond market is the biggest in the world; it’s the most liquid and therefore it’s quite considerable for international investors. However, I think that one of the key problems that American policy makers face is that this is an ongoing fiscal dysfunction. We were down on this road back in 2011 when America was stripped of its triple A status by Standard and Poor’s, and then we had the fiscal cliff at the end of 2012, when there was real risk of America falling back into economic recession, and here we go again with the shutdown and the debt ceiling crisis. And I think these periodic crises undermine confidence in US economic policy; they undermine confidence in the US dollar as the world’s leading reserve currency. And if this dysfunction continues, then over time international investors will be looking for a reform of the international monetary system and they’ll be challenging the role of the dollar as the leading reserve currency.

RT:China's state news agency is calling for the world's de-Americanization. How's that going to happen?

NM: I’m not entirely sure about what they mean by de-Americanization. Certainly from the financial and economic point of view, I think all this uncertainty that’s been created by fiscal policy and the risk that it could, in the worst case scenario, push America back into recession which would have negative consequences for the global economy at a time when the recovery is very hesitant, very uneven. There are question marks about its sustainability – this is really the last thing that we need. I think that de-Americanization, certainly from my perspective, would mean a gradual ongoing loss of confidence in the US dollar as the leading US currency, ongoing loss of confidence in US economic policy, which would hasten diversification away from foreign investment in US debt market. And that would make it much more difficult for the American government to fund its deficits. It previously and still does rely on foreign investment which is why China and Japan - America’s main foreign creditors, the countries that have the largest foreign holdings of US treasuries - are concerned. China and Japan have been urging America to bring about an early resolution of this problem. If it doesn’t, then I think over the longer term the dollar will decline and its importance will move to a multipolar currency system. The currencies will take onboard more importance. That I think is going to happen anyway. The global economy is changing, there’s shift in the center of gravity from West to East. So called emerging economies are already incredibly important for the global economy and will continue to be so over the longer term. These changes that are taking place could easily be accelerated by the problems we are seeing in America at the moment.

RT:  Is the Eurozone in a similar position now with an almost equal amount of debt?

NM: The Eurozone debt and banking crisis have been fairly quiet during the course of this year. But a lot of fundamental problems have not been resolved. The Eurozone does not have a single federal government like America does, and so one of the problems in the monetary union is a very unbalanced system. We have a single monetary policy, single interest rate policy, single currency, but we don’t have a single fiscal policy. And there are still considerable pressures as regards fiscal policy in the Eurozone. Many government debt GDP ratios are still on a rising trend, and in many cases above a hundred percent of GDP which is widely regarded as unsustainable. Many Eurozone banking systems have considerable exposure to domestic sovereign debt, which is an unhealthy development. There are lots of structural problems – unemployment, the lack of economic growth, obsession with austerity. Although the Eurozone crisis is very much on the back burner at the moment because of the current problems in America, it does not mean that they’ve necessarily gone away. In that regard many international investors are still quite cautious about the situation and about the possibility that we could see a fresh flare-up in the Eurozone crisis at some stage. 

RT:  The deadline for raising the debt ceiling is October 17. What happens if the US lawmakers fail to meet the deadline?

NM: As far as the deadlines are concerned for the debt ceiling which is this Thursday, there is a risk that unless there is an early deal – and certainly the financial markets are hoping that it’s going to happen – the drop dead deadline as it’s called is the end of October. And really in the first half of November we’ve got about $70 billion worth of payments for social security, for veterans’ payments. We’ve also got about $35 billion worth of interest payments to be paid. And if they are missed in any way then you get a technical default. There’s quite a challenge for the US Treasury to prioritize its payments. It will get about $300 billion worth of revenues over the first half of November. But it will have to prioritize what bills it pays first. The longer this goes on, the more nervous investors will be, more downside risks for the global financial system, more of a chance that the US economy falls into recession, which would inevitably have a knock-on effect elsewhere in the global economy. So, the consequences of not meeting these deadlines are quite considerable.