In the dollar we trust? Yes, but for how much longer?

None of those things happened to the US, at least to the degree that one would consider a crisis. Even if the US delays or misses some payments, chances are people will still hold US dollars and US Treasuries, not abandoning them entirely, as textbooks predict they would do for other countries.

For one thing, the situation arises not out of the United States’ inability to service these debts and obligations, but out of the legal and political barriers that bar the government from borrowing from the market. Its debt serviceability is still high. 

As evident in the yields its T-bills and bonds command, markets are still willing to lend to the US. Although its one-month T-bills command a yield 10 times as high as at the start of the shutdown, its yield was a meagre 0.32 per cent on October 15.

Treasury bonds have a completely different story: One-to-10-year Treasury bonds were traded at 0.16-2.75 per cent on October 15, actually lower than when the market was speculating that the US Federal Reserve might taper its quantitative easing programme during early September. So the market consensus considers QE3 tapering more of a risk to the US Treasuries than the shutdown and debt-ceiling talks.

With inflation of 1.5 per cent, we may say that the market is actually subsidising the US government to borrow, not at all near the cost of borrowing we saw for Greece or other countries, whose debt serviceability was called into question. Hence even if the US loses its highly coveted “AAA” rating from all three major rating agencies, it will most likely be only one notch downward and not a slip into junk status.

In addition, admittedly and unfortunately, the US has been here before. The market still remembers the 2011 and 2012 fiscal stand-offs vividly, in which a deal was struck literally minutes before disaster. Hence, this time around, the market expected no less from US politicians: brinkmanship to the last minute.

Nonetheless, had the US selectively defaulted, the ripple effects would have spread throughout the global financial markets, probably more than hitting the US Treasuries themselves. Being the world’s safest assets, all risk pricing across asset classes would require re-pricing to indicate higher risk of US Treasuries. 

A recent joint conference by the Bank of Thailand and the International Monetary Fund had a session dedicated entirely to the issue of global safe assets. And since safe assets cannot be privately provided (actually the financial markets tried but failed miserably, and ended up with a sub-prime crisis), investors only look to public issuers to meet the demand. The supply is lopsided, however. Only the highest-graded sovereign debts can be considered safe enough, and that list is shrinking, not expanding. Hence the world hoarded US dollars and US Treasuries for the lack of better alternatives. 

Some figures will help put things into better perspective here. Of around US$5.4 trillion daily foreign-exchange turnover in the global market, 87 per cent of the exchanges are of the US dollar for some other currency. Well, if you think this is due to the United States’ dominance over the world economy, here are some more figures to ponder. The US accounts for roughly 19 per cent of world gross domestic product, and its trade accounts for 12 per cent of world trade value. 

This wasn’t because most of the exchanges happened in US financial centres like New York, as 40 per cent of the transactions took place in London, while about 19 per cent happened in the US. In other words, the US dollar is not a major currency in the world, it is the main currency. Hence the importance of the US dollar seems over-inflated.

Nonetheless, in the long run, if the US continues this political game, eventually the market will get tired of forgiving the US dollar. This process nonetheless will be slow. 

Other choices as the main currency follow the US dollar in very distant importance. The euro follows next with 33 per cent of forex transactions, while the Japanese yen comes in third with 23 per cent. However, if you remove the exchanges between these two currencies, their shares drop to 9 per cent and 2 per cent respectively. 

The Chinese yuan, on the other hand, is far down the list with 2 per cent of global transactions, and after removing yuan-dollar exchanges, we are left with pretty much nothing. 

As you can see, the dollar dominance is pervasive and hard to get rid of.

Don’t put all your eggs in one basket, it is said. But apparently, for our need of currencies and safe assets, we don’t heed this advice. This is partly the investors’ fault, but also the lack of safe assets on the supply side is also to be blamed.

Now that the US has shown more instability, the faith in the dollar will get tested and the market will slowly seek other safe assets to balance the increasing risk. This list may include euros, yen, Swiss francs, British pounds, and Canadian or Australian dollars – and even gold for reserves. 

But until we get there, it will be undeniable that the dollar will remain the main vehicle for global exchanges. Indeed, the world is still in dire need of another safe asset – and the US dollar is slowly losing its credibility as one.

 

Views expressed in this article are those of the author and not of TMB Bank or its executives. Dr Benjarong Suwankiri is head of TMB Analytics, the economic analysis unit at TMB Bank. He can be reached at [email protected].