Default Averted: Implications for the Americas?

Late Wednesday evening (October 16), President Obama signed into law an agreement reached by Congress in the eleventh hour to raise the federal debt ceiling. As the October 17 deadline crept closer, finding a compromise to avoid the first default in modern U.S. history was more urgent than ever. And though lawmakers finally hammered out an agreement that garnered 81 votes in the Senate and 285 in the House to end the two-and-a-half-week government shutdown and extend the country’s borrowing limit, the damage is, in some ways, already done.

In simplest terms, a failure to raise the debt ceiling would have prevented the U.S. government from meeting its debt obligations abroad—but it is lenders’ faith in the U.S. commitment to meeting those obligations that has provided for much of the global financial system’s security for over 60 years.

Initially, Senate and House leadership had each worked on competing legislation to avert default and end the shutdown. But late Tuesday evening(October 15), the House ended their negotiations, having failed to reach an agreement. And Wednesday afternoon(October 16), the Senate announced its bipartisan bill—and even Senator Ted Cruz (R-TX), who led the hardline Republican camp in the negotiations, vowed that he would not attempt to delay its passage. In its final version, the Senate bill ended the shutdown and raised the debt ceiling, leaving both to be reconsidered early next year.

Amidst this congressional turmoil, public opinion and consumer confidence have bottomed out. A recent ABC poll revealed that disapproval of the GOP’s budget dispute dealings has grown by 11 percentage points—from 63 to 74 percent—since the shutdown began. And, in an unusual development, fewer than half of Republicans approve of the way their own party’s congressional representatives have handled the debate (President Obama, in contrast, currently enjoys 71 percent in-party approval; congressional Democrats enjoy 61 percent.)

Even though this round of crisis has been avoided—and narrowly—many fear that the new mid-January and early February deadlines for the budget and debt ceiling, respectively, will raise the same—if not more—controversy all over again. Given the future uncertainty, it remains reasonable to consider the effects should lawmakers fail to come together in time during the next iteration of these perennial debates.

Economists across the political spectrum largely agree that a U.S. default would wreak havoc on a global economy still recovering from the 2008 financial crisis. A recent Goldman Sachs report estimated that the U.S. economy would contract by four percent in the event of default—and, as the past has shown, a recession in the United States is unlikely to leave other economies unscathed.

So—with the U.S. government slowly emerging from this crisis—and amidst concerns that lawmakers might not come together in time to do the same early next year, what would a failure to come to an agreement mean for Latin America?

 Q1: What effect would a U.S. debt default have had on the hemispheric financial system?

 A1: The most immediate effect of a U.S. default would be on the global financial system itself. Because U.S. Treasury bills have long been considered the least risky investment available—precisely because the United States has never defaulted on its obligations—they underwrite the global financial system, serving as its very foundation.

 With a U.S. default, lending would quickly dry up, and credit markets would grind to a halt. And though the U.S. dollar serves as the world’s reserve currency, long a boon for the U.S. economy, that status would be threatened, as rising interest rates and a plummeting dollar value would be difficult to avoid. In reaction, global stock markets would plunge. Unemployment would rise.
 In short, the turmoil of the 2008 recession would likely pale in comparison to the economic consequences of default—and, to be sure, Latin America could hardly hope to escape scot-free.

Of the hemisphere’s economies, Mexico, which sends roughly 80 percent of its exports to the United States, likely has the most to lose should the United States enter another recession. Given the two countries’ economic interdependence, the fate of the U.S. financial system goes hand-in-hand with Mexico’s own.

Brazil, in contrast, has seen its currency strengthen recently over speculation that the government shutdown would force the U.S. Federal Reserve to scale back its “quantitative easing” program. Still, Brazil would suffer should international financial flows freeze up—as would the rest of the region’s economies.

The region still has several dollarized economies—namely, Ecuador and Panama—that would be heavily affected by the rapid decline in value of the dollar. Inflation here at home would translate clearly to those countries that rely directly on the dollar, generating negative economic circumstances in many of our closest neighbors.

And because of the U.S. role as the region’s biggest trade partners, no countries would remain unaffected by a failure to meet the deadline.

Whatever the controversy here in the United States, the potential economic effects of default for rest of the region—while difficult to predict—would likely be severe.

Q2: What could a default imply for regional perceptions of the United States?

A2: Economic effects aside, the default would also carry implications for global (and, specifically, regional) perceptions of the United States. Already hurting from the acrimonious budget debate and the ensuing shutdown, perceptions of the United States abroad could enter into free-fall if a lawmakers fail to compromise on an issue so key to the U.S. government and the world.

When looking to the United States, foreign leaders—and particularly those in the region—increasingly see a rudderless government unable to perform its most basic functions. A full default would amplify these feelings—particularly given that the United States has long preached the importance of meeting debt obligations to global financial markets, adding to the charge that much of U.S. foreign policy relies on a “do as I say, not as I do” logic.

In short, trust, both diplomatic and economic, in the United States would continue to ebb should Congress fail to meet its next set of deadlines—and the damage to its ability to work with and influence partners could take some time to repair.

Conclusion: It is far from surprising that a U.S. debt default would have global repercussions. Still, lost in the ongoing debate over the role of “Obamacare” in the shutdown and looming default are the strategic implications of both for U.S. foreign policy, particularly in the Americas.

The last decade has seen the dramatic expansion of Chinese influence in the region, in the realms of economic partnerships and diplomatic engagement alike. In many ways, a U.S. default would open the door to still further Latin America-China partnerships, as countries throughout the Americas turn east for support and leadership in the absence of both from the United States.

And, despite its own economic problems, the European Union stands to gain regional influence as well. Like the Chinese Renminbi, the Euro would likely strengthen if the dollar’s place as the global reserve currency falters. If the European Union and China prove themselves more reliable partners, why would our hemispheric neighbors choose to work with the United States?

This issue of influence is part and parcel to the challenge Congress currently faces. When caught up in a partisan debate seen by many as purely domestic in nature, it is pivotal to remember that goings-on here at home carry broad implications internationally—particularly given that, even having averted the crisis for now, it will inevitably resurface in the near future.

Ultimately, with the deadline met for now, the global financial sector will likely bounce back accordingly—and even so close a call may soon be forgiven. Perceptions of the United States, however, may take longer to recover, as partisan intransigence and legislative inefficiency might continue to bode ill for our relations abroad.

So, then, with default narrowly avoided and the next deadline looming just months away, what will Congress do to ensure the place of the United States in the region?

Carl Meacham is director of the Americas Program at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Jillian Rafferty, staff assistant, and Michael Graybeal, program coordinator and research associate, both with the CSIS Americas Program, provided research assistance.

Critical Questions is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).

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