Dollar bulletproofs US economy

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US DollarThe 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 assets. The signal being sent to the markets is that the world economy is still in a fragile state and that the American economic recovery, which is at best stuttering, is yet to convince.

The main reason that the global financial system is still fragile is that it is so unbalanced. World GDP is about $US70 trillion, which is about 18 days trade in the global financial markets. Annual transactions in the global capital markets are about $1400 trillion, 20 times world GDP. The financial system has become a Leviathan sitting atop the 'real' economy, taking its signals from that 'real' economic world, but at the same time influencing what happens in the 'real' world.

Traders try to work out what everyone expects the markets to do, then look for ways to exploit the predicted outcome (which is one reason why predicted outcomes rarely eventuate; traders put in counter bets against them which often create the opposite result). In this case, the predicted outcome is that the US dollar will fall because of doubts over its safety, stock markets will fall as investors head for the exits and interest rates will stay low because the US Federal Reserve will continue its aggressive printing of money (quantitative easing). Some or all of that may occur, but it also may not, because large bets will be made against it.

What is certain is that the stand off will have a negative effect on American business. American business leaders are mostly siding with President Barack Obama in his battle with the House Republicans. The President midweek hosted 14 chief executives from the nation's biggest financial firms. The Chamber of Commerce, a business advocacy group, has sent a letter to Congress signed by about 250 business groups urging no shutdown and warning that a debt ceiling crisis could lead to an economic disaster.

This is resulting in what might be described as a civil war in America's business community. The so called Tea Party Republicans are in large part being funded by right wing business figures who are determined to push an anti-government political agenda. This is intimidating more moderate Republicans, who are worried that such heavy funding will affect their chances of being pre-selected if they are not seen to co-operate. Right wing business interests, in other words, are driving the political agenda.

Yet businesses that are less ideological are aghast at the implications of the shutdown. It is usually their preference not to be politically partisan, but Obama seems determined to draw them into the political arena. One of the outcomes of the stand off is that business in America may become more politically engaged.

David James headshotDavid James has been a business journalist for 25 years and is the author of Managing for the Twenty First Century and The Business Devil's Dictionary. He has a PhD in English Literature from Monash University.

US Dollar image by Shutterstock.

Topic tags: David James, America, shut-down



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Thanks for a very perceptive article; what outrageous numbers and what a bizarre system! I suppose debt too does not matter for the US if they can just print more bills? Except perhaps for inducing inflation, but rather like Churchill and alcohol, I`ve got as much out of inflation as inflation has got out of me! In my experience inflation (not necessarily hyper-inflation) is good for the young (with mortgages) and bad for the elderly (if on fixed incomes).

Eugene | 07 October 2013  


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