15-6-2023 (LONDON) With the last-minute resolution of the US debt ceiling crisis, a sigh of relief was felt in global financial markets. However, the manner in which the issue was resolved has reignited worries over America’s dominant position in the world economy at a time of low growth, high inflation and an unstable banking system.
There is huge uncertainty over how these challenges will unfold. But political deadlock in Washington, the rise of populism and a retreat from free trade indicate that the US may lack the means and will to handle another global crisis as competently as before.
Recalling the 2008 global financial crisis, we witnessed how instrumental the US was, domestically and internationally, in resolving the crisis. There is little evidence the US would demonstrate the same commitment today.
The US Federal Reserve was crucial in 2008, stabilising the global banking system by lending over $1 trillion to other central banks through currency swaps, injecting money into the system. This enabled the bailout of European banks by providing much-needed dollars. This year, at the peak of the March banking crisis, the Fed again provided daily currency swaps to central banks.
In 2008, the US also pushed major economies to adopt expansionary policies to avoid a global recession. It enabled the IMF to make $1 trillion available to stabilise threats to the system and aid emerging and developing economies. And through the G20, the US led the creation of the Financial Stability Board to ensure the stability of large global banks.
Recent events have exposed weaknesses in the system. The failure of some US regional banks and the rescue of Credit Suisse, one of 30 systemically important financial institutions, show the crisis may not be over. There are worries over the shadow banking sector, largely unregulated institutions now comprising half of global financial assets. In the US, many invest in uninsured money market funds offering higher interest than banks.
The post-2008 regulatory system has been ineffective or weakened. The US eased regulations and capital requirements for regional banks under Trump, despite lingering concerns. G20 geopolitical tensions, like over Ukraine, have also weakened the FSB’s impact.
There are reasons to doubt the Fed would lead another large-scale bank rescue. Unlike in 2008, the Fed now faces conflicting pressures to curb high inflation, which could surge if it cuts rates to save overextended banks. For the same reason, the Fed would be reluctant to further boost growth, fuelling inflation.
The Fed’s ability to rescue banks, domestically or internationally, is limited by its huge balance sheet from 2008 which it’s reducing by $30bn, soon $60bn, per month. Its authority to issue swaps could also be challenged by politicians questioning helping economic rivals.
Threats of inflation and slow growth remain unaddressed in the US and Europe, undermining central banks’ credibility to manage economies. Meanwhile, the value of assets backing the global financial system, like US Treasury bonds, has fluctuated dramatically due to banking and debt crises and ballooning US debt.
Recent Republican efforts to block spending bills could prompt a government shutdown, further weakening America’s credit rating.
All this has put huge strain on banks worldwide. Growing tensions in the global financial system and a weakened US retreating from global affairs could endanger the world economy.
