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 50.

    JfH: "If the truth ever becomes known: the USA and its awful banks are totally and irretrievably bankrupt"

    Many of its banks are, and have folded. The truth is that the federal govt of USA is not bankrupt, debt as %age of GDP is only c75% which is high but not awful - not really much different to having a mtg at 3x salary. At state level the position is often much worse

  • rate this

    Comment number 49.

    Financial crises creep up on you and then go bang. Everything seems quite normal up till then. If you act on the explosion then you are too late. The sound money has gone and hid somewhere. The cheap money, the sort the taxpayer funds, will continue sloshing around until it goes up in flames. So, mark my words, the taxpayer can look forward to yet more baling out of busted fools.

  • rate this

    Comment number 48.

    28 Welcome to capitalism. The people or institutions who have it don't actually want it back at all , what they want is the interest payments from it (i.e. a share of taxes from everyone else). Why actually work for a living when you can live very nicely off the interest alone, so long as the nominal capital is protected.
    It is basically welfare for wealth - provided courtesy of everyone else.

  • rate this

    Comment number 47.

    JfH @33-35
    "problem is:
    bankrupt (except that states print or default & survive);
    crushed critical academic economics (founded on uncritical greed);
    (Congress) in cloud-cuckoo-land (actually, in comfort, thank you);
    exact opposite of the founding fathers (themselves corrupt-split);
    fools on blogs (blind to) aberrant decades (millennia fear & greed)

    "You are the problem", ducking equal partnership

  • rate this

    Comment number 46.

    The real question is how have they spent that $17trn? What have they got to show for it?
    Lots and lots of extremely expensive weapons, most of which are unecessary and obsolete. Subsidised (GM) food, a very good road Network.

  • rate this

    Comment number 45.

    @ 36 "because the markets are about as closely linked to the "real value" of a business/item/currency as I, a white Englishman am to Nelson Mandela!"

    ... so pretty closely related in the broad scheme of things then?

  • rate this

    Comment number 44.

    bitcoin anyone ?

  • rate this

    Comment number 43.

    "What I dont understand is where the US has borrowed $16.9 Trillion from? Who has that kind of money& why dont they want it back?"

    They borrow it from everyone all over the world, from individuals who invest in pension funds to corporations who have wish to have their cash invested in a relatively safe asset

    The real question is how have they spent that $17trn? What have they got to show for it?

  • rate this

    Comment number 42.

    America is floating along on a sea of unsustainable debt, along with many other countries. If you have to borrow simply to service your own debt it's time to call in the payday loan companies! We all hope America won't sink but the present insight into the mentality of the USA politicos' reveals a frightening scenario of navel gazing, posturing and a a refusal to wake up and smell the coffee.

  • rate this

    Comment number 41.

    If you can run a financial institution on the basis of fractional banking and magically create money, then I suppose you can also run a country on the basis of fractional intelligence.

  • rate this

    Comment number 40.

    This is not a crisis at all, its posturing politics.
    At 1 minute to midnight the Americans will agree to keep printing more debt. Just like they always do, and will do again and again.

    I'm just wondering which unexpected and random event will actually trigger the uncontrollable collapse of the whole house of cards?Summer of 1914 again?

  • rate this

    Comment number 39.

    @22 FauxGeordie "...most of the growth under Obama has been compounded interest..."

    Annual interest payments have been below $500,000,000,000 while federal deficits have been above $1,000,000,000,000, so I think you might be technically incorrect. But a federal deficit of more than 40% of tax revenue is certainly in need of attention.

  • rate this

    Comment number 38.

    Non-sharing rich, led by US & UK, cut work & growth, here & abroad, to keep their treasury bonds 'less unsafe', less unattractive, to keep-up re-sale prices, to prevent fixed annual 'coupon' payments from raising prospective yields (that would force new-issue treasuries - their govt borrowing - to be higher-coupon), fearing bulges beyond payment from growth, so more cuts, QE, death of Golden Goose

  • rate this

    Comment number 37.

    It is only some US legislators who have taken the world's reserve currency and the biggest economy hostage to exact ideological concessions on policies that received a mandate last November. Roberts blogs need to have a listed status to preserve a rapidly diminishing facility of being able to comment. BBC use to run an excellent blog site but now....

  • rate this

    Comment number 36.

    you could ask this question about the stock market too... and it's a very simple answer... because the markets are about as closely linked to the "real value" of a business/item/currency as I, a white Englishman am to Nelson Mandela!

    The entire recession the markets traded at about the level they did before, propped up by Money printing, all a sham for short term gains for a few.

  • rate this

    Comment number 35.

    There are fools on this blog who think that the capitalist system can work with nugatory priced money. You are THE problem. Are you unable to see what has happened during the aberrant two decades long experiment we are living through?

    We have far too much money - because its cost is and has been far too low. Result asset bubbles and a bust financial system (live zombies & dead good businesses).

  • rate this

    Comment number 34.

    The idiots on the hill live in cloud cuckoo land. This is the best explanation of the stupid budgeting and tax system of the USA. It is designed to help only the fattest of the cats whilst crushing the poor and impoverished people - the exact opposite of the founding fathers' aegis of the USA. The country is now far more corrupt than they worst African or Middle Eastern despot. It will change!

  • rate this

    Comment number 33.

    If the truth ever becomes known: the USA and its awful banks are totally and irretrievably bankrupt.

    The problem is that this zombification of the whole economy appears OK as the banks first crushed all critical academic economics.


    Capitalism requires (as it always has done) that the price of money is positive OR the whole edifice of trade and commerce grinds to a halt and collapses.

  • rate this

    Comment number 32.

    It seems to me that a handful of stubborn and egotistical Republicans are holding the US and the World to ransom. Despite losing the 2012 election, despite Supreme Court rulings, despite the will of the American people they seem intent on scuppering ObamaCare purely for ideological reasons.

    The fact that they are putting the Global Economy at risk is of no consequence to them.

  • rate this

    Comment number 31.

    "What I dont understand is were the USA has borrowed 16.9 Trillion dollars from? Who has that kind on money and why don't they want it back?"

    No - probably not

    Its an investment - a loan is always an asset to a financial institution.

    They could put it somewhere risky and maybe earn more (or see it turn to nowt) or they can put it in US treasuries and earn not much but always get paid



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