US House Speaker Kevin McCarthy (left) looks on as President Joe Biden speaks during a meeting on the debt ceiling in the Oval Office of the White House in Washington on May 22. Photo: AFP
Opinion
Macroscope
by David Brown
Macroscope
by David Brown
Even with a tentative US debt ceiling deal, Washington needs reform or the dollar will suffer
Markets should be relieved Biden and Congressional Republicans have struck a deal ‘in principle’, but the debacle was wholly unnecessary
While the dollar is not going to fade away, more crises like this one will erode its standing and ensure the yuan becomes more appealing
US President Joe Biden has reportedly struck a tentative deal with Republican House Speaker Kevin McCarthy to hopefully avoid a devastating debt default before the government runs out of money in little more than a week’s time.
The deal still needs approval from a divided US Congress. However, the markets should be relieved that a truce has been reached in principle on raising the government’s US$31.4 trillion debt ceiling limit.
It’s a crisis that should never have happened in the first place. The fact US lawmakers on Capitol Hill were prepared to stare each other down in a game which could still end up in a catastrophic US default, an unthinkable downgrade in the US’ triple-A credit rating, or another global crash in the worst-case scenario, is an unforgivable act of political recklessness.
Confidence in the US government debt market has been holed below the waterline. For long-term holders of US Treasuries, especially large official reserve managers such as China and Japan, it would be no surprise to see investors looking to hedge their bets in future.
While the debt ceiling crisis appears to have been avoided for now, the problem is not going to go away until US leadership mends its ways. The US budget mess has gone on far too long, with successive governments spending too freely and taxing too little. The endless supply of Treasury bonds to plug the budget deficit not only causes a huge drain on world savings; it also poses a major threat to global financial stability.
The US dollar is such a cornerstone of the global capital markets and international payments system that another run-in of this magnitude could be the last straw. Something needs to change, and quickly. Either the US government puts its house in order or rational investors will vote with their feet.
It’s already happening, as the dollar’s position as the world’s benchmark currency comes under threat and the process of de-dollarisation – the decline of the currency’s role in global financial transactions – gains momentum. The big issue is which currency will rise to the challenge. Among the major international reserve currencies, the euro, Japanese yen and China’s yuan are all competing to chip away at the dollar’s supremacy in the future.
The yuan has plenty of catching up to do to become a universally accepted currency but it remains best placed to challenge the dollar in the long term, considering the mainland’s economic strengths. China is the world’s second-largest economy and a global manufacturing powerhouse.
Employees work on a truck production line at a Shaanxi Automobile Group factory in Xian, in central Shaanxi province, on May 17. Photo: AFP
It boasts the world’s largest foreign trade surplus and holds the biggest stock of foreign exchange reserves, worth US$3.2 trillion. These features alone should put the yuan head and shoulders above its rivals. Even so, global investors remain wary, especially when risk aversion remains high and flight-to-quality is paramount.
The yuan still only accounts for less than 3 per cent of official global currency reserve holdings, compared with 58 per cent for the US dollar and around 20 per cent for the euro. According to data from the Bank for International Settlements, the yuan is the fifth-most actively traded currency on global foreign exchanges but still has a long way to go to catch the dollar, euro and yen in popularity. But that can only improve as Beijing’s currency policies gain greater recognition.
China’s objective should be a long-term process of attrition. Building confidence based on improved market transparency, better convertibility and greater trust will be essential. That means a currency market free from political interference and devoid of official market manipulation. To boost the yuan’s global role, international investors must be won over with a hearts and minds programme that succeeds in opening doors and facilitates more efficient trade.
The good news is that China’s closest rivals have problems of their own. The euro might be the world’s second-most actively traded currency, but market faith has never quite recovered from the European debt crisis, when the euro’s existence came into question.
Likewise, Japan’s yen might be a popular safe haven for investors when risk aversion is high, but the currency’s general appeal is marred by years of economic stagnation, deflation and negative interest rates.
The US dollar is not going to fade away any time soon. Perceptions of the currency might have taken a reputational beating, but US policymakers have had a wake-up call. It’s up to the US to change its ways or suffer the consequences.
David Brown is chief executive of New View Economics
