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ECONOMICS

Dollar bulletproofs US economy

  • 04 October 2013

The extraordinary stand off in America over the budget shutdown is harming the credibility of the United States economy and the American dollar. Hundreds of thousands of government employees, many of them poorly paid and financially vulnerable, are out of work. There are increasing concerns that the Congress will not allow the $17 trillion debt ceiling to be raised, which may result in America defaulting for the first time in its history.

And the reaction of the markets? To rush into US dollars, causing the greenback to rise. If that sounds contradictory, it is. Yet it is also quite logical. Because if there is one currency in the world that is not in danger of becoming untradeable, it is the US dollar.

Consider some of the basic sums. America's economy is $16 trillion a year. America's debt ceiling is $17 trillion in total. The trade in the US dollar is about $4 trillion a day. That means that in just over four days, the global capital markets transact the equivalent of America's entire government debt. True, much of that activity is derivatives and other forms of meta money. But there is no risk of the market for American dollars drying up, which means that a default by the American government is, while significant, not especially relevant to what happens with the global trade in US dollars.

America is fond of claiming exceptionalism, which is usually little more than a revealing indication of the nation's questionable attitude to moral accountability. But in one area America most definitely is exceptional: the global currency markets. The US dollar is the world's reserve currency, and consequently America can make economic and fiscal choices that are not available to any other country.

If, for example, a Latin American nation or a South East Asian nation defaulted on its debt, the currency would collapse, then the banking system would collapse because debt held in foreign currencies could not be paid. Then the whole economy would collapse. Indeed, that is exactly what happened during the Latin American debt crisis of the 1980s and the Asian financial crisis of the 1990s.

But the American dollar rules the world, and so America has options no other country enjoys. What, then, are the likely consequences of the current political stand off? What most matters in global capital markets are financial or economic signals, which are interpreted by traders to change pricing of different kinds of