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How Debt Ceiling Standoff Can Permanently Damage US Dollar, Markets

How Debt Ceiling Standoff Can Permanently Damage US Dollar, Markets

John Kicklighter,

Talking Points:

  • The Dollar and US Treasuries are considered absolute havens, but that status is not a permanent one
  • Another debt ceiling stand off in the US government risks further escalating the risks only glimpsed in 2011 and 2013
  • A reduced position as a reserve currency and market can result in systemic changes for the US and global markets

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In the event of a global crisis, investors seek shelter for the funds in the form of absolute safety. While different people attach the 'haven' status to many different markets (gold, Euro, bunds, Bitcoin), that is more loose language or wishful thinking than practical assessment. When the financial system seizes, there are no legitimate equals to the US Dollar and Treasuries. That is, there hasn't been an equal. That may change moving forward - not owing to other markets rising in prominence but due to the US benchmarks losing their status. There are a few developments that could accomplish the heavy fundamental lifting necessary to lower the status of the Greenback - the premier haven for decades. A localized ans systemic US crisis, China overtaking the United States in financial girth and the detrimental side effects of an isolationist shift by the country. Yet, the most tangible high profile change currently at play is the risk of a value downgrade by rating agencies and the global financial system.

Once again, the US faces a deficit and budget cliff. If legislators cannot reach an agreement by September 29th, the US government may be shutdown and/or the country may enter a technical default. This is not the first time the country is racing to the edge. There were similar crises back in 2011 and 2013. In the first standoff, a last minute deal was struck to extended funding for a few years, but the damage was meaningful. The US capital markets stumbled and drug global risk trends with them. The lasting scar came when rating agency Standard & Poor's cut the country's AAA credit rating - fundamentally changing the unassailable argument made for the United States' financial safety. In the following brinkmanship moment, the government was forced to shut down as funds ran dry. The markets however remained sanguine and rating agencies stayed their hands. The markets were growing acclimatized to the unprecedented development, the this was not a disregard for the long-term fallout. Eventually, absolute risk aversion will again rise. At that point, US havens will be put to the test.

With the deadline once again looming, majority leaders in both the Senate (McConnell) and House (Ryan) along with the Treasury Secretary (Mnuchin) have voiced confidence that the debt ceiling will be raised with no problems. Yet, President Trump had different views on the situation when he remarked at his Arizona rally earlier this week that he may have to force a government shutdown to secure funding for the border wall championed during his campaign. While some are playing down the aggressive language, we have seen what has happened when the US President's conviction is discounted. What's more, a technical default is not really necessary to having a negative effect on US assets and the financial system. The mere threats will weigh rating groups' and market participants' confidence in the US Dollar and Treasuries perpetual safety status. Fear that yet another stand off can be scheduled for the future could motivate money managers to start assessing diversification plans now when conditions are calm. Nascent reserves like the Chinese Yuan can more quickly rise in prominence and the trouble behind the Euro could be tamped down as prioritization shifts. We discuss the systemic risk posed by debt ceiling standoffs along with the implications for the Dollar, 'risk' and gold in today's Strategy Video.

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