Ever since the Republican Party won control of the House of Representatives, in November 2022, the United States has been trapped in a standoff that could spark a major economic crisis. Republicans have refused to increase the U.S. debt ceiling—a legislative limit on the amount of money Washington can borrow to pay its bills—unless U.S. President Joe Biden consents to large spending cuts that he has so far rejected. The showdown is becoming increasingly urgent. The United States technically hit its debt cap in January this year, and the tools the U.S. Treasury Department is using to keep Washington within its limits cannot work much longer. If Republicans and Democrats do not reach a deal by the end of June, the country will default for the first time in history. 

    Because a default would be unprecedented, its exact consequences are difficult to predict. But American politicians have held the debt ceiling for ransom before. In 2011, the United States came within days of defaulting after Republicans and Democrats struggled to reach an agreement on increasing the debt ceiling. A close study of that experience helps show what the current confrontation might bring for the United States and the world economy. During the 2011 debt-ceiling crisis, a key credit agency downgraded the United States’ rating, global stocks slouched, and emerging-market countries’ bond prices fell as Washington inched closer to a default. The credibility of U.S. currency was affected, as well. As the showdown went on, the value of the dollar weakened. According to data I gathered from the International Monetary Fund, U.S. dollar reserves held by central banks around the world also dramatically declined. Today’s battle, if it becomes serious enough, will likely have similar consequences. 

    In fact, the escalating showdown could be even more damaging. There is never a good time for economic difficulty, but a severe impasse today will hit the United States at a moment when it is slowing, inflation is higher than it has been in four decades, and interest rates have reached a 15-year high. Because the United States is the world’s largest economy, any crisis it faces will almost certainly spread to other countries. A default or protracted showdown could therefore prompt severe, worldwide economic turmoil. 

    For Washington, the damage from a serious debt-ceiling crisis won’t be limited to the economy. The United States derives tremendous geopolitical power from the dollar’s status as the world’s leading currency. Because most international trade is in U.S. dollars, the United States can print money to pay for goods that it buys from abroad, allowing it to finance a large international trade deficit without having to worry that it will run out of cash. The wide use of the dollar also makes it easy for Washington to implement effective sanctions, because it can cut its adversaries off from much of the global financial system simply by restricting their access to the dollar. But a severe debt-ceiling crisis could cause much of the world to stop trusting the currency, accelerating the end of its international supremacy and, with it, these privileges. It would be a spectacular debacle—weakening the U.S. economy and undermining the United States’ international standing—of the country’s own creation.

    For anyone watching today’s debt-ceiling drama, the story of the 2011 showdown will sound very familiar. In November 2010, Republicans won control of the U.S. House of Representatives. Shortly after, the party demanded that U.S. President Barack Obama agree to extensive spending cuts if he wanted to raise the debt limit. But Democrats refused to budge, so the two parties spent the next six months fiercely fighting over how to resolve the impasse. 

    The battle left a clear footprint on global financial markets. Each news event that suggested Democrats and Republicans were struggling to reach an agreement—such as when bipartisan deficit-reduction talks among six high-profile senators fell apart on May 18—caused global stock market prices to drop by roughly 0.5 percent on average. These events also caused emerging bond prices to fall, on average, by just over 0.1 percent and the U.S. dollar to decline by 0.25 percent against other major currencies. From the beginning of May to the end of the crisis, in July, global stock markets decreased by seven percent cumulatively. The U.S. dollar depreciated by almost 4.0 percent against the Japanese yen and 4.5 percent against the British pound. The fall in the U.S. dollar was large even against traditionally risky emerging-market currencies. It depreciated by about 2.5 percent, for example, against the Chinese yuan. Overall, the global share of foreign currency reserves held in U.S. dollars decreased by 1.4 percent during this period—more than four times the average annual decline since the beginning of the millennium.

    So far, financial markets have not been fazed by the current debt-ceiling showdown. But as the crisis begins to truly take hold, the interest rates for U.S. Treasury bonds could spike as they become riskier investments. This surge in yields could then drive up financing costs everywhere as the world’s safest asset—one that typically sets the floor for borrowing costs—suddenly becomes more expensive. The consequences for other countries would not be mild. In 2011, during the last debt-ceiling crisis, global financing costs were generally low, and emerging markets were receiving large amounts of international investment. Today, however, high interest rates mean that most economies are facing tighter financial conditions and high borrowing costs. Sovereign debt levels are at record highs, and many countries have not fully recovered from the economic consequences of the pandemic. In this context, a shock to U.S. Treasury bonds could escalate into a wave of corporate and sovereign defaults. 

    A jolt to treasuries could also further jeopardize the dollar’s international standing. The share of international reserves held in dollars has already fallen by over two percent since the end of the 2011 debt-ceiling crisis, as several countries have worked to have their currencies more widely used in international transactions. The global order has become more fragmented, and Washington has increased its use of sanctions, further pushing the United States’ adversaries to bypass the world’s dollar-centric international payment system. China, in particular, has moved to internationalize its currency, for example, creating a small offshore yuan market and a yuan-based payments system. It recently struck a deal with Brazil to conduct trade in the two countries’ currencies, and it is discussing a similar arrangement with Saudi Arabia. Another severe debt-ceiling showdown in the United States, especially a default, would help Beijing’s cause. 

    Dislodging the U.S. dollar from the international financial system will not be easy. The dollar has been the dominant global reserve currency since the end of World War II, and it still accounts for approximately 58 percent of international allocated currency reserves. The world has a longtime habit of using dollars for international payments, and the U.S. economy’s size and stability mean the dollar remains attractive. There is also no clear replacement. China’s economy is large, and Beijing is clearly working to promote its currency, but the yuan is subject to capital controls that make owning and exchanging it for other currencies difficult. As a result, the yuan will struggle to truly go global. The euro, meanwhile, is plagued by other issues. Most investors cannot hold a single European bond; they can hold only bonds issued by individual European countries, each of which has different risks and liquidity, making it harder to accumulate euro reserves.

    But the dollar could lose its dominance even without a clear successor. The international economic order could instead give way to a multipolar currency system, in which countries use a variety of currencies to trade, including those of growing, emerging-market economies. Such a system will become much more attractive if the U.S. government is no longer willing to unconditionally commit to pay back the United States’ debts. By increasing the risk of owning Treasury bonds, which make up U.S. dollar reserves, a severe debt-ceiling crisis could be the catalyst for such a change. 

    For Washington, this would have serious consequences. Because international trade takes place mostly in dollars, the United States does not need to accumulate foreign currency reserves. Central banks everywhere else, however, need dollars to finance their imports. To do so, they hold large quantities of U.S. Treasuries, which lowers U.S. borrowing costs. The dollar’s widespread use in international transactions thus gives the United States the exorbitant privilege of trading and borrowing in its own currency at favorable rates. It also provides the United States with a powerful geopolitical lever. The world’s reliance on the U.S. dollar payment systems allows Washington to unilaterally sanction other states causing major economic effects. But if countries can easily deal in other currencies, Washington will no longer be able to singlehandedly penalize its adversaries in an effective way.  

    Given all these consequences, it would be geopolitical malpractice for leaders in Washington to risk defaulting over the debt ceiling. But the country is more polarized now than it was in 2011, and there is still no clear plan for avoiding a default—even as the clock continues to tick down. In a fit of pique, the world’s most powerful country could both damage the global economy and erode a key source of its own strength.