U.S. Debt Default Could Trigger Dollar’s Collapse – and Severely Erode America’s Political and Economic Might

For American companies, the dominance of the dollar means they aren’t as subject to the exchange rate risk as are their foreign competitors. Exchange rate risk refers to how changes in the relative value of currencies may affect a company’s profitability.

Since international trade is generally denominated in dollars, U.S. businesses can buy and sell in their own currency, something their foreign competitors cannot do as easily. As simple as this sounds, it gives American companies a tremendous competitive advantage.

If Republicans push the U.S. into default, the dollar would likely lose its position as the international unit of account, forcing the government and companies to pay their international bills in another currency.

Loss of Political Power, Too
Since most foreign trade is denominated in the dollar, trade must go through an American bank at some point. This is one important way dollar dominance gives the U.S. tremendous political power, especially to punish economic rivals and unfriendly governments.

For example, when former President Donald Trump imposed economic sanctions on Iran, he denied the country access to American banks and to the dollar. He also imposed secondary sanctions, which means that non-American companies trading with Iran were also sanctioned. Given a choice of access to the dollar or trading with Iran, most of the world economies chose access to the dollar and complied with the sanctions. As a result, Iran entered a deep recession, and its currency plummeted about 30%.

President Joe Biden did something similar against Russia in response to its invasion of Ukraine. Limiting Russia’s access to the dollar has helped push the country into a recession that’s bordering on a depression.

No other country today could unilaterally impose this level of economic pain on another country. And all an American president currently needs is a pen.

Rivals Rewarded
Another consequence of the dollar’s collapse would be enhancing the position of the U.S.‘s top rival for global influence: China.

While the euro would likely replace the dollar as the world’s primary unit of account, the Chinese yuan would move into second place.

If the yuan were to become an a significant international unit of account, this would enhance China’s international position both economically and politically. As it is, China has been working with the other BRIC countries – Brazil, Russia and India – to accept the yuan as a unit of account. With the other three already resentful of U.S. economic and political dominance, a U.S. default would support that effort.

They may not be alone: Recently, Saudi Arabia suggested it was open to trading some of its oil in currencies other than the dollar – something that would change long-standing policy.

Severe Consequences
Beyond the impact on the dollar and the economic and political clout of the U.S., a default would be profoundly felt in many other ways and by countless people.

In the U.S., tens of millions of Americans and thousands of companies that depend on government support could suffer, and the economy would most likely sink into recession – or worse, given the U.S. is already expected to soon suffer a downturn. In addition, retirees could see the worth of their pensions dwindle.

The truth is, we really don’t know what will happen or how bad it will get. The scale of the damage caused by a U.S. default is hard to calculate in advance because it has never happened before.

But there’s one thing we can be certain of. If Republicans take their threat of default too far, the U.S. and Americans will suffer tremendously.

Michael Humphries is Deputy Chair of Business Administration, Touro University. This article is published courtesy of The Conversation.