Why hasn't the debt ceiling debacle cracked confidence in the dollar?

White House and parking metre

In the week the father of efficient market hypothesis, Eugene Fama, received the Nobel Prize for Economics, it is moot whether the behaviour of investors - as uncertainty escalates over whether the US can pay its debts - supports or disproves the idea that markets are the best information processing machine we have.

To the bystander (and unfortunately none of us can really be dispassionate bystanders on this, because if the dollar goes pop, we're all covered in goo), what's going on looks odd.

On the one hand, it has become a bit harder and more expensive for the US to borrow for very short periods by issuing three-month and six-month Treasury bills.

Arguably, that represents a rational response by investors to the growing risk that Congress will not approve an increase in the debt ceiling, or the amount the Federal Government can borrow, by Thursday's deadline, and that the Federal Government will struggle - for a bit at least - to repay maturing debts.

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If the dollar goes pop, we're all covered in goo”

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So in that sense investors are taking seriously the extraordinary looming prospect of the government of the biggest economy in the world, whose currency and debt underpin the entire global financial system as - in effect - the collateral and benchmark for all financial transactions, defaulting on what it owes.

Now you might think if that were to happen, the status of the dollar as the world's reserve currency - the currency that oils the wheels of global capitalism - would be called into question, and that momentum would build in some way to develop a new reserve currency.

And as the ratings agency Fitch, either helpfully or unhelpfully pointed out Tuesday night - when signalling the strong likelihood (I would say the racing certainty) that it will strip US sovereign debt of its AAA accreditation - were the dollar to lose its reserve currency status, all sorts of bad things would follow for the US economy.

Not least of those bad things would be that the cost of borrowing for US government, households and businesses would rise in a sustained way, with a detrimental impact on the long-term growth prospects for that economy.

Dollar bill in foreign exchange sign The dollar is still seen as a safe haven

Now here's the funny thing. This crisis has not yet led to any significant increase in the implicit cost for the US government of borrowing for 10 or 30 years. In fact the price of US Treasury bonds is actually higher than it was just a few months, which implies that it is cheaper for the US government to borrow.

What on earth is going on? How can investors hate dollar debt that has to be repaid tomorrow, but love dollar debt that is due for repayment in 10 years?

Well, it is for three reasons, of which two are semi-rational and one seems a bit bonkers.

The semi-rational ones are these:

First, it is very likely that the partial shutdown of the US economy, caused by the failure of Republicans and Democrats to agree a budget, the impasse also underlying the debt-ceiling debacle, will take momentum out of America's economic recovery.

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There are no serious candidate currencies to replace the dollar as a reserve currency”

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Also the uncertainty over whether the US will default may be depressing economic activity.

So the reasonable calculation is that in those circumstances the US central bank, the Federal Reserve, will continue to buy official bonds, and create new money, at a rate of $85bn a month, for rather longer than would otherwise have been the case.

That, to state the blinkin' obvious, underpins demand for US government debt, and keeps borrowing costs low.

Second, there are no serious candidate currencies to replace the dollar as a reserve currency in the short term.

The idea of the euro becoming the world's reserve currency would be regarded as laughable by most investors, at a time when few of them are convinced that the euro is forever - even if there hasn't been a major eurozone accident for a couple of years.

Currency exchange in Hong Kong China's yuan is also known as the renminbi, or RMB

And for all the incremental steps to liberalise China's capital and foreign exchange markets, the RMB is a million miles from being a liquid, easy-to-trade currency. It is a long way from offering a safe haven alternative to the dollar (although George Osborne's attempts to establish the City as the main offshore centre for RMB trading shows what he thinks about the long-term trend - see The risks for the City of becoming China's offshore centre).

As for the long-discussed ideas that the rich countries of the world will get together to promote some kind of new-fangled, mutually supported reserve currency, the notion may be attractive but the technical difficulties are immense.

So, for now, the dollar is the only reserve currency we have.

But here is the paradox which would be a masterpiece of surrealism if you could hang it on the wall.

What almost always happens when there is global economic and financial uncertainty is that investors flock to the dollar as that vaunted safe haven.

And even though it is the dollar that is the very source of our current global economic and financial uncertainty, there is no stampede out of the US currency. In fact on Tuesday, it strengthened a bit.

If you wanted to rationalise what's happening, you would say the following: that investors are convinced that Congress will come to its senses and that there will be no long-term damage, from the global media spectacle of US legislators holding the prosperity of the world to ransom, to confidence in the safe haven status of US official assets.

Or you might argue that most investors find it difficult to see further than the end of their noses or the close of the trading day, whichever is sooner.

Robert Peston Article written by Robert Peston Robert Peston Economics editor

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  • rate this

    Comment number 290.

    Oh alright, BBC, I'll tone it down, then.

    sieuarlu @ 284, you're a tad too nationalistic.

    "We spend as much on our military as the next 28 countries combined."

    True. None of it earned - all borrowed.

    "We have by far the strongest military in the world."

    You wish. Your much-vaunted (by Hollywood) armed forces haven't won even a single war or campaign in nearly 70 years.

    Polite enough, Beeb?

  • Comment number 289.

    This comment was removed because the moderators found it broke the house rules. Explain.

  • rate this

    Comment number 288.

    In the real economy of the world, there's the US....and then there's everyone else. Who is number two? No it is NOT China, it's Japan. GNI not GDP is what matters. So do other factors such as the ability to be completely self reliant indefinitely, social stability, the attraction of talent from around the world. Japan has about half the US economy but has many problems.The US will remain on top.

  • rate this

    Comment number 287.

    286"The markets knew the US was not going to default. That was never an option."

    It was considered unlikely but not because it would have been foolish but because the side that wanted it didn't have the political power to pull it off....this time.

  • rate this

    Comment number 286.

    Because it is was all just a game. The markets knew the US was not going to default. That was never an option.

    Pathetic isn't it? - it reminds me of the cold war, It's all very childish and frankly irresponsible.

  • rate this

    Comment number 285.

    here is another puzzle how does Japan
    the country with the largest and longest running QE
    still fight DEFLATION
    also with highest govt debt levels junk credit rating status
    still have low bond yields
    the answer is the economic models have no grasp of reality
    in particular the real monetary power of sovereign states
    you have to go outside the mainstream for such understanding
    google MMT

  • rate this

    Comment number 284.

    283 Don't we wish. We have by far the strongest military in the world. We spend as much on our military as the next 28 countries combined. What's really behind the strength of the USD is the power of the American economy, the largest, most productive, most efficient engine for generating wealth ever created by man. The rest of the world's economies are connected by belts and pulleys to it.

  • rate this

    Comment number 283.

    The US dollar is backed by their military, the threat of violence, and foreigners blood. And widespread market manipulation.

  • rate this

    Comment number 282.

    280 More advice from people whose legacy is that once their currency was the world's safe haven. But it hasn't been for the better part of a century. The Empire that sustained it is gone. The US doesn't have an empire, never did. The US dollar became the world currency because of the way the US is managed. We don't expect outsiders to understand it. I think it's well beyond them.

  • rate this

    Comment number 281.

    Maybe because someone sold paper future contracts worth 2 million ounces of gold on the COMEX, in the space of 3 minutes, in normally thinly traded overnight hours, which effectively smashed the gold price down $80 an ounce, tus protecting the price of the dollar against real money.

  • rate this

    Comment number 280.

    If the USA was not the lead currency in the world and seen as a safe haven because of that fact things would be totally different then we could see how well they could manage their country. I am still sure they could do it but they would not get away with financial debts etc as easily as they do and we would not be as badly affected by their actions since the 2008 crisis.

  • rate this

    Comment number 279.

    Lots of sour grapes out there. Lots of people think they know how to run the US better than Americans do. But what have they done with their own economies? Not well at all. The neat thing about the US is that it once was and could be again almost entirely self reliant. It also is constantly reinventing itself. Now it will not only have all the food, raw materials, technology it needs by energy too

  • rate this

    Comment number 278.

    "Why hasn't the debt ceiling debacle cracked confidence in the dollar?"

    Because when you get down to the real nitty gritty of it there's nothing else on earth remotely like it. Barely a year ago it wasn't certain if the Euro would even survive. Other nation's economies like Britain's and Switzerland's are too small, others too unstable.USD will survive no matter what. Others might not.

  • rate this

    Comment number 277.

    275. rootsman time take it easy
    "How much longer can the US get away with printing a trillion $s of ‘new money’ annually?"
    "17 more years is how long it will take based on servicing debt at low benchmark interest rates of 0.1 - 0.25% as t per debt management agreement to avoid insolvency"

    AHHH BUT who is buying the $ ?....ANSWER the FED mainly & there is already pressure on interest rates

  • rate this

    Comment number 276.

    Lessons learned from biannual debacle
    1 You can be most popular president ever, but step out of line with stuff like droning and spying and you will be hounded out of office every day as people can't wait to see you go and don't care if next chump is worse, you blew it

    2 Government contracts ain't worth jack-you're supposed to get annual salary by contractual law which is scam
    tools down

  • rate this

    Comment number 275.

    "How much longer can the US get away with printing a trillion dollars of ‘new money’ annually?"
    17 more years is how long it will take based on servicing debt at low benchmark interest rates of 0.1 - 0.25% as the per debt management agreement to avoid insolvency

  • rate this

    Comment number 274.

    .As the WRC the $ looks like its dying

    Oh and do not be surprised to see a run on CHASE BANK in the US as they seem to be limiting cash withdrawals and overseas wire transactions !

  • rate this

    Comment number 273.

    The Fed "will continue to buy official bonds, and create new money, at a rate of $85bn a month, for rather longer than would otherwise have been the case."

    Is it really new money?

    Dividing a cake into more slices doesn’t make the cake any bigger.

    How much longer can the US get away with printing a trillion dollars of ‘new money’ annually?

  • rate this

    Comment number 272.

    The real reason the markets never tanked or the dollar implode is because no-one with more than 100,000 bucks in his bank account really believed the US would default.

    The Republicans and Democrats and just two sides of one party, the business party and its the only game in town.

    The idea that they would ever do anything to seriously disrupt business is ludicrous and the markets knew it...

  • rate this

    Comment number 271.

    I suggest that the markets are rigged

    Looks like the $ is dying and Robert could you check reports that CASH WITHDRAWALS ARE BEING LIMITED AT CHASE BANK IN THE US!


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