(The Telegraph) - Interest rates will soar. The stock and bond markets will crash. And the global financial system will be plunged into turmoil as investors flee to any safe asset they can find.
With every day that passes, the clock is ticking steadily closer to the deadline for a deal between President Joe Biden and Congress on lifting the debt ceiling for the United States.
If a deal isn’t done by June 1, the global economy, at least according to most of the experts, will be facing a catastrophe of epic proportions as the US defaults on its debts.
Obviously, that outcome is hardly going to make for a smooth ride. If it happens, there will be a few days of turmoil. And yet, an American debt default would be precisely the wake-up call the world needs.
In reality, we have spent the last 20 years piling up more debt and bigger deficits as if all that money would never have to be paid back. It has stoked inflation, fuelled bubbles in every kind of asset, channelled capital into the most unproductive investments possible and hooked governments on big spending programmes that we can’t afford.
In truth, some kind of deal will probably be stitched together at the last minute to stop the US from defaulting. But it might be better for all of us if it wasn’t.
There are less than two weeks left until the deadline expires. On June 1, the US will technically default on its debts unless the President and Congress can hammer out a deal that lifts the current debt ceiling.
The Republicans don’t want to increase it beyond the current $31.3 trillion (£25.1 trillion) unless the White House agrees to control its spending and ease the tax burden. Perhaps unsurprisingly, the Democrats and the President think another few hundred billion should simply be nodded through as if it didn’t matter. We will see what happens as next week unfolds.
And yet there is one point on which everyone agrees. A default would be catastrophic for the global economy. Jeremy Hunt, the Chancellor, has warned that the impact would be "absolutely devastating", while the White House Council of Economic Advisers forecasts that it would trigger a deep recession, with a 6.1pc drop in GDP in the US alone.
In other words, it would be pretty bad. It is not hard to work out why. In effect, the American government would have to stop paying many of its bills, as it did briefly in similar stand-offs when Barack Obama was president. Even more seriously, the bond markets would be in turmoil, with Treasury bills, the benchmark against which everything else is priced, in freefall, and with investors trying to figure which government might be next. Understandably, everyone wants to avoid that kind of chaos.
Even so, despite the potential for a financial meltdown, an American debt default might be precisely the kind of jolt that the global economy needs.
It would be a powerful reminder that total borrowing can’t simply keep on rising forever without any consequences.
According to figures from the IMF, total global debt has risen from $200 trillion at the start of the 2010s to $300 trillion now. At the end of the decade, it will be $400 trillion and still rising.
Within that, there has been huge rises in state debt. Japan’s debt-to-GDP ratio has hit a staggering 225pc. Italy’s ratio has hit 140pc, France 111pc. The UK - no slouch when it comes to borrowing money over the last few years - has just gone through 100pc, a level that used to be regarded as the upper limit possible without triggering a collapse of confidence.
It is not just governments. Corporations have been borrowing money on an epic scale, with companies around the world owing a combined $87 trillion, or 97pc of global GDP. And consumers have been borrowing just as much. Add it all up, and we live in a world that is literally drowning in debt.
We can see the consequences of that all around us. Inflation has taken off again, racing passed 10pc at its peak in the US, and the same level in the UK and in most of Europe as well.
With so much borrowed money chasing a fixed level of goods, it is no great surprise that prices have started to accelerate, and although rising interest rates will start to bring that under control again, we will also need less debt as well.
Next, it has stoked up asset prices, creating mini-bubbles from internet stocks, to cryptocurrencies, to property, stocks and bonds.
Thirdly, it has kept zombie companies alive, and funneled investment into unproductive industries where there is little hope of any proper returns ever being made.
Finally, and perhaps worst of all, it has allowed the government to get bigger and bigger, fuelling its expansion with borrowed money rather than by raising taxes, pandering to unrealistic demands from their voters for more and more spending.
At a certain point, all that borrowing needs to stop growing. True, a default by the US government would be a nasty shock.
The financial markets would panic, bonds would crash, stock markets would keel over, and, in many cases, it would create real hardship for federal employees.
And yet, it would not be forever. No doubt a compromise would be worked out within a few weeks to allow the US to go on borrowing again. In the meantime, it would be just the kind of dramatic, symbolic wake-up call the global economy needs right now.
The party has to stop one day. We can’t just keep on borrowing more and more money for ever. At some point the books will need to be made to balance again. The start of June might be a good place to begin – even if it causes some temporary pain.
By Matthew Lynn