Why it's a bad idea to gamble with the credit rating of the United States

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Marco Werman: I'm Marco Werman and this is The World, a co-production of the BBC World Service, PRI, and WGBH-Boston. No sign of a breakthrough in Washington today, but as bad as the federal government shutdown may be, there's another even bigger battle looming on Capital Hill. The US is set to run out of cash on October 17 unless Congress raises the debt ceiling by then. Richard Parker teaches at Harvard University's Kennedy School of Government. I asked him why the rest of the world is so concerned about what happens with our debt limit.

Richard Parker: Because the global economy is deeply intertwined and especially intertwined with America. At the end of the Second World War, the US was half of the world's economy. Today it's still a quarter of the world's economy. And more important, the dollar is the currency that's used in transactions around the world. Something like 80 percent of all commodity transactions around the world are denominated in dollars, and US treasuries are considered the equivalent of the gold standard, the very best, most reliable, form of sovereign debt, that is of government debt, that's issued anywhere in the world. And when other countries get in trouble or the world seems shaky for even the slightest moment, billions upon billions of dollars rush into the United States and the United States has enormous advantages economically by having that reputation as being an unimpeachable borrower which repays every cent that it borrows.

Werman: So, just so we don't lose anyone here, basically raising the debt ceiling is like requesting a raise on your credit limit on a charge card. It would allow the US government to borrow more, and, I guess, spend more, right?

Parker: Yeah, that's exactly right. The government takes in basically taxes, but the taxes don't cover what the government spends each year. We could have an argument about whether we should raise taxes, but the difference between what a government takes in and it spends is covered by its borrowing. It borrows in the markets, and the markets price that debt, meaning they determine what the effective interest rate is that the government will pay by the credit-worthiness of the government. The United States government has an exemplary credit rating because it has not ever defaulted on its debt in its entire history. If that reputation is broken, it's going to send a shudder through bond markets, through stock markets, through global economy.

Werman: What has happened historically when great powers do default on their debt?

Parker: Well, lots of things, which is that those great powers oftentimes discover that they're not great powers anymore. Historically, in the period of the early modern nation-state, kings oftentimes defaulted on their debt and it led to repeated crises that often were preludes to the overthrow either by new kings or by irate citizens.

Werman: You have a good illustration for us?

Parker: Well, yeah. The French repeatedly defaulted on their debts and the accumulated liabilities that then made the taxation of the populous even greater of course led to the revolution of 1789 and the beheading of the king and his wife.

Werman: Now, officials at the International Monetary Fund say even a temporary failure of the US government to pay its bills would have a catastrophic impact on the global economy. Can you unpack that for us a bit? I think most international players watching this abroad would expect that Democrats and Republicans would wrangle for a bit but ultimately strike a deal. Why the panic?

Parker: Well, let me stand back and say, you know, the IMF is right to say catastrophe because what would flow from an unresolved debt default, a failure of the Congress to raise the debt limit, would, if not resolved, prove a real catastrophe. That is, markets would become highly unstable because people would suddenly not know what kind of world they're in or how to price the future. We could expect that stock markets would go down. We're in the midst of a fragile global recovery right now, as every American listening knows, and you could essentially throw the brakes on that recovery and actually throw the gears into reverse. In other words, we could get a major new recession out of this beginning early next year.

Werman: How nervous are you right now?

Parker: I think we've got a one-in-three chance that we're going to go over this cliff.

Werman: Richard Parker, professor at Harvard's Kennedy School of Government. Thanks so much.

Parker: Good to talk with you.