What if United States fails in honoring its payment obligations?

In China, Beijing maintains capital controls. The Chinese Communist Party (CCP) has been tightening its influence over the economy for years, raising questions about just how secure it is to use the yuan. This is good news for the US, but it may soon be old news. Failure by the US to honor its payment obligations, or even the possibility, would put such concerns in a very different perspective.

An outright default by the Treasury Department on US government debt would be enormously disruptive to the global financial system. Michael Feroli, Chief US Economist at JPMorgan Chase says, “It is quite plausible that it would precipitate a severe financial crisis.”

If Congress doesn’t raise the debt limit, the Treasury can employ a variety of highly questionable maneuvers to keep honoring US obligations. But doing that might shake investor confidence in the rule of law in the US, Feroli wrote in a note to clients Friday. By autumn, Wall Street analysts predict, the Treasury will be forced to decide whether to use those tricks or default on payments.

Biden and Xi Jinping have been sparring over whose political-economic system is a better model for human development. In his first address to a joint session of Congress as president two years ago, Biden said, “Xi and other autocrats think that democracy can’t compete in the 21st century with autocracies because it takes too long to get consensus”.

Washington has gone through debt-limit battles repeatedly over the years, and yet the role of the US$ and broader credibility of the US in the global financial system has remained strong. What’s different this time is the leverage far-right Republicans in the House have thanks to concessions by Kevin McCarthy in his desperate fight to become speaker. 

“Even the best case will probably see the sort of brinksmanship that occurred in the 2011 debt ceiling crisis,” Feroli said. And that episode resulted in a stock-market selloff that went global.

As compared to 2011, China today offers a much more attractive alternative to US financial markets. For one thing, it’s now open to foreign bond and equity inflows in a way that it wasn’t back then. After China finishes its abrupt, wrenching and catastrophically deadly reopening, the economy ought to be humming. It is near US$4 trillion central government bond market has plenty of scope to boost overseas ownership.

The potential contrast could have long-term effects, at a time when even some Western money managers question the relative merits of the two systems.

“Given the bickering in the US, it is no longer clear that the US form of democracy clearly works better than the autocratic CCP approach,” said Stephen Jen, who runs Eurizon SLJ Capital, a hedge fund and advisory firm in London.

US political partisanship is a major factor from which the Chinese Communists have derived considerable confidence in themselves.