Steps to avert global financial shockwaves

Financial conditions in the United States have been deteriorating at an alarming rate for some time.

With the recent signing into law of the "One Big Beautiful Bill", the US budget deficit is expected to increase by trillions of dollars, and the national debt as a percentage of GDP is projected to rise to 127 percent by 2034, far higher than after World War II when it was at its highest. The cost of interest on the national debt has surpassed both the US' massive military budget and its spending on Medicare, the government medical insurance program for seniors.

With Moody's downgrading its US credit rating from Aaa to Aa1, all three major credit rating agencies — S&P, Moody's and Fitch — have downgraded their ratings. Yields on US Treasury bonds have increased, reflecting a concern that US Treasuries may not be the world's safest place to park money unlike before.

Nevertheless, prominent US economists are not panicking. They believe that the US dollar is in a slow decline, but they do not predict a crisis.

Harvard University economist Kenneth Rogoff predicts that the "era of the US dollar may be winding down", but does not predict it to be sudden. Cornell University economist Eswar Prasad, an expert on the economics of money, said the US dollar can survive the current administration's wrecking ball.

But what if they are wrong, and something sudden is lurking? US economist Herbert Stein famously said, "If something cannot continue forever, it will stop." But will it stop suddenly, or will it simply peter out?

It can be challenging to predict a financial crisis or a run on a bank. A financial crisis is triggered by a sudden and cascading loss of trust, much like the spread of an especially viral disease.

If distrust in the dollar and in the ability of the US to make good on its debt reaches a tipping point, the rush to get out of the dollar could become a stampede.

The confidence of economists is not necessarily reassuring.

Consider the onset of the 2007-09 financial crisis. Shortly before the crisis set in, economic and monetary experts such as Ben Bernanke and Alan Greenspan, both former chairmen of the US Federal Reserve, publicly expressed their belief that the US was in a period called the "Great Moderation", in which measures to decrease financial risks had been successful and had brought about an era of relative stability.

In the media, there were mildly concerning stories about the possibility of subprime mortgage defaults, but since subprime mortgages were understood to be a small percentage of all mortgages, they were not interpreted as warnings of a major financial crisis.

In early October 1929, US economist Irving Fisher proclaimed that "stock prices have reached what looks like a permanently high plateau".

Shortly thereafter, on Oct 29 — Black Tuesday — stocks dropped precipitously, initiating a long series of steep drops and leading to the Great Depression.

Therefore, the confidence of prominent economists is not enough to assure the extreme unlikelihood of a new crisis.

Now the US stock indexes can also be taken as reaching another high plateau, after breaking record highs in recent months while the US' debts piled up.

The latest high tariffs imposed by the US against major trade partners further complicate its economic prospects and financial markets.

The question is, should we begin to think seriously about the possibility, however remote, of a new financial crisis due to a sudden, cascading loss of trust in the US dollar? Should economists be focusing on this question, even as they offer assurance that this scenario is extremely unlikely?

Another faction, like the faction opposing thinking about the unthinkable nuclear war, might argue that thinking openly about the possibility of a new major financial crisis might contribute to causing it, by subtly undermining trust — and that is a possibility. But perhaps thinking about it seriously could help to mitigate the damage if the unimaginable occurs.

A financial crisis resulting from a run on the dollar would have extremely serious implications for the entire world, especially since no alternative is poised to take its place. Scenarios as to how this might play out, what its effects would be, and how the worst could be averted, should be drawn up.

The author is a mathematician and economist with expertise in finance, energy, and sustainable development. He is an adjunct professor at the Hong Kong University of Science and Technology.

The views do not necessarily reflect those of China Daily.