Deficits, the dollar and US decline

28 Oct 13
Christopher T Mahoney

Suggestions of US economic decline following the deficit dust-up and shutdown should not be believed. There is no credible threat to the global dominance of the dollar, and a eurozone crisis is more likely than a dollar-zone crisis

The financial media (especially in Europe, and especially at the ) have been rife with commentary about America's sad decline as an economic superpower as a result of the latest government shutdown and the latest debt ceiling kerfuffle.  ‘Can these people govern themselves?’,  ‘Are Tea Party crazies running America?’, etc.

It is solemnly agreed by saddened commentators that global investors have lost confidence in the US as a result of the recent dust-up. This most recent discrediting of the US follows many previous discreditings, when foreign investors lost confidence in the United States, its currency and its debt: the ‘Constitutional crisis’ of Watergate, the double-digit inflation of the Carter era, the ‘massive deficits’ of the Reagan years, the fiscal profligacy of the Bush tax cuts and, most recently, Obama's ‘massive’ stimulus and trillion-dollar deficits.

Global investors must be exhausted by the experience of repeatedly losing confidence in the United States. You'd think by now that Treasury bonds would be used as toilet paper like the Zimbabwe trillion dollar note.

Isn't it odd then that Treasury yields have steadily fallen throughout the ‘crisis’, and that this banana republic can borrow money for 30 years at 3.6%? And isn't it odder still that the worthless dollar and the dodgy Treasury Bond continue to constitute the majority of foreign central banks' international reserves?

Perhaps these central banks didn't get the memo that they were supposed to flee the dollar and buy yuan or bullion or pork bellies. The Dallas Fed got the memo.

What the FT and other serious commentators forget is that the US Treasury bond is a monopoly product because it is the only security denominated in US dollars issued by an entity that can print US dollars. Like Porsche, there is no substitute.

Let's look at the T-bond’s competitors: eurozone government bonds, Japanese JGBs, British gilts, and not much else. What about the yuan, every journalist’s favourite currency these days? Like the North Korean won, the Cuban peso and the Venezuelan Bolivar, the yuan is nonconvertible, and thus useless as a reserve asset.

Eurozone government bonds? Too small a float to be liquid in an emergency, not denominated in any country’s domestic currency, and most eurozone governments are far from AAA. Japanese JGBs? A huge market, but not as liquid as one would think, in the wrong time-zone, and nowhere near AAA. Not a good substitute for the greenback.

Central banks must be able to provide dollar liquidity to their members at all times because the business of international finance is conducted in dollars. Thus, whenever there is a market convulsion, banks require dollars from their central banks to meet dollar claims, which is why the Fed is asked to establish dollar swap lines during financial crises. The alternative would be for central banks to fire-sale their own currencies in the middle of a crisis.

There are no credible threats to the global dominance of the dollar and the T-bond. Treasury yields have never been lower, despite trillion-dollar deficits and deteriorating debt ratios. A dollar-zone crisis is much less likely than a eurozone crisis; Japan’s debt-trajectory is asymptotic; and the UK's credit was wounded by the financial crisis.

The US is not a pretty credit, like Estonia or Botswana (no debt), but it will remain the Number One credit for the rest of this century, no matter what Fitch and S&P have to say about it.

Christopher T Mahoney is a former vice chairman of Moody’s. This is an edited version of a post that first appeared on his

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