Could a US debt default cause global turmoil?

The US government is now working on what could be one of the most expensive chicken games of all time.

If Democrats and Republicans do not agree to allow the US to borrow more, or in their words, to raise the debt ceiling, the world’s largest economy will lose $31.4 trillion (£25 trillion). will default on its debts.

They need to come to an agreement before the eerie-sounding “X date” on June 1st.

But if not, what would that mean for other countries and for you?

First of all, none of the experts the BBC spoke to believe the US will default on its debt.

But if it does, “the global financial crisis will look like a tea party,” said Simon French, chief economist at investment bank Panmure Gordon, after the global banking industry nearly collapsed in 2008. He touched on that.

Unless the U.S. raises its debt ceiling, it will be unable to borrow any more and will soon run out of money to pay public benefits and other obligations.

“When people lose their welfare and assistance payments, it hits their ability to spend and pay their bills,” said Russ Mold, investment director at AJ Bell. “So it’s going to hurt the economy.”

Economist Mohamed El-Erian, president of Queen’s College, Cambridge, said a default would “probably send the U.S. into recession.”

It would also have significant ripple effects in the rest of the world, where the United States is a major trading partner.

“The United States is one of the world’s largest trading partners. The United States will buy less from other countries,” he said.

In addition to hurting trade, French said a U.S. debt default could lead to higher mortgage rates in other countries and a rise in unemployment.

“It’s going to be a pretty catastrophe,” he says.

Why would US problems make other countries’ mortgages more expensive?

When a government wants to borrow money, it issues bonds or IOUs. In the United States, they are called Treasury bonds. Interest is charged to the government when investors buy US Treasuries.

If the U.S. government doesn’t repay its debts, or even interest, “investors will see this and say, ‘If the U.S. could default, what is stopping the U.K. from defaulting? Will you say?” says Mr. French.

Investors could then demand higher interest rates to buy government bonds.

“The interest rate on debt, whether it’s mortgage debt or public debt, is a clue to how much risk is perceived and is clearly [a US default] It’s a huge risk event, so all the debt will become expensive overnight,” he says.

In fact, borrowing is likely to be generally more costly for governments, businesses and citizens.

“U.S. government debt is in many ways seen as the foundation of the global financial system,” said Andrew Hunter, deputy chief U.S. economist at Capital Economics.

“Usually it is considered the single safest asset, and essentially every other financial asset in the world is priced almost out of U.S. government debt.”

The good news, he said, is that if the U.S. defaults, no particular country will be vulnerable.

What’s the bad news? “It’s really just going to be potentially catastrophic for the global economy.”

The US dollar is the world’s key currency.

What this means is that a long list of important commodities, such as the oil used to make gasoline and the wheat that is ground to make bread, are priced in dollars.

If the U.S. government defaults on its debts, the value of the dollar is expected to drop significantly.

While that may sound like good news to people outside the United States, it means that commodity investors “don’t know how to price commodities,” French said.

“What happens if the US defaults? Investors suddenly panic and think, ‘Is Japan next? Britain next? Germany next? What else will default?’ ” he said.

“Suddenly you have to re-price everything, and in economic terms it is a risk premium.

Rising food and fuel prices will raise the cost of living for millions of people.

The U.S. accounts for 60% of the value of global stock markets, Mold said.

“So people could have exposure to U.S. stocks in their pensions whether they know it or not,” he said.

And the stock market is likely to react badly to a US default.

But it’s not all hopeless and bleak.

In 2011, Democrats and Republicans were in a stalemate over the debt ceiling hours before a possible default.

The US stock market plummeted. But the scare didn’t last long, and stocks recovered from the plunge.

Mold expects that to be the case this time as well.

People who are currently receiving pensions may also be affected, but “if they are receiving pensions at some point in the future, they will have time to make up for the shortfall,” he said.