The Dangers of the US Cancelling Foreign Debts: A Closer Look at Economic Repercussions

Unless a country is in debt to the federal government of the United States, the USA does not have the authority to cancel foreign debts. Even if the US federal government were to forgive a debt, it would not necessarily result in any significant change for the debtor or the US itself. However, from a strategic and financial perspective, the decision to cancel foreign debts bears several risks, particularly when considering the complexity of the global bond market and the role of credit ratings.

Bond Market Dynamics and the Impact of Debt Forgiveness

Bonds operate on a complex system where debt is transferred from one party to another. When a debtor declares that a bond is worthless, it does not suddenly nullify the underlying debt. Instead, the bond remains in the possession of the new owner, who can continue to sell or trade it. This means that even if the US government were to unilaterally declare a particular bond worthless, the underlying debt would still carry value on the secondary market.

The US has a significant presence in the global bond market, having sold trillions of dollars worth of bonds backed by the US government. These bonds are owned by a multitude of institutions, from banks and individuals to other sovereign nations, and are widely traded. If the US were to suddenly declare these bonds worthless, it would create chaos in the bond market, as investors seek to unload these “worthless” assets. This could lead to a sharp drop in the value of US government bonds, potentially causing a crisis in the credit market.

Repercussions on International Credit Rating

Cancelling foreign debts would almost certainly result in a drastic drop in the US credit rating. The current US credit rating is Triple A, which is the highest possible rating, signifying the lowest risk of default. A drop to junk status would have far-reaching consequences, including a decrease in the value of US treasury bonds. Foreign-held stocks and bonds would also be devalued, as the backing that these assets previously had from US government debt would vanish.

This would not only affect foreign investors but also the US itself. As the credit rating falls, the US would become riskier to lend to, leading to higher interest rates on any future debt issuance. This higher cost of borrowing would add to the overall financial burden of the US, complicating efforts to manage its debt. Moreover, a lower credit rating would make it harder for the US to engage in international trade, as trading partners would likely demand higher collateral or stringent payment terms. This could stifle economic growth and exacerbate existing economic challenges.

Domestic Debts and the Complexities of Multidirectional Obligations

It is also worth considering the domestic dimension of US debts. Some domestic debt is also held by foreign entities, which means that cancelling foreign debts would not necessarily resolve the issue for domestic creditors either. The US relies on the steady repayment of its debts to maintain its Triple A credit rating, as losing this status could lead to economic stagnation and financial instability.

Given the interconnected nature of global finance, unilaterally deciding not to pay domestic debts to ensure foreign holders are not paid is a risky proposition. It could create legal and economic dilemmas, potentially leading to lawsuits and international disputes. Furthermore, such a move could be seen as a destabilizing action, damaging the US’s reputation in the global financial community.

Conclusion

While the cancellation of foreign debts might seem like a radical solution to address the debt crisis, it is fraught with significant risks and potential repercussions. The bond market, the role of credit ratings, and the interconnected nature of domestic and foreign debts all contribute to the complexity of such a decision. The US should consider these factors carefully to avoid exacerbating existing economic challenges and creating new ones.