It might be early days yet, but there are indications that the ratings downgrade of the United States sovereign debt has done nothing to erase the dollar’s special position as the numeraire of international transactions, the currency of choice in international trade, the currency most favoured by governments for keeping their reserves, and the instinctive home for money in troubled times. However, the downgrade might be the most forceful reminder ever that the dollar’s special status might be lost at some point in time. That view is based on a better understanding of what the lowered rating signifies as well as on the stock market behaviour in the days following the downgrade. A reflection of the weakened fiscal stature of the world’s largest economy, the downgrade is attributed to “the political discourse that has diminished the credit standing of the U.S.” The long-term outlook for the U.S. remains negative: further downgrade has not been ruled out if the fiscal position does not improve.
Those are strong words under any circumstances, enough to sink the financial markets. However, even as the stock markets across the world turned extremely volatile, skittish investors sought the sanctuary of U.S. government treasury instruments. Ironically, treasuries are still considered a haven although the U.S. government itself is seen to have precipitated — or is at the centre? — of a crisis. The day after the SP downgrade, the 10-year yield, instead of rising, fell by 25 basis points and hit an all-time low last Tuesday. Various studies have shown that in times of great global uncertainty the demand for U.S. government paper goes up. That has enabled the U.S. to lower its cost of debt. Governments around the world continue to keep a large part of their reserves in dollars. According to the IMF, the dollar’s share of global reserves was as high as 60 per cent as on March 31, followed by the euro (26.6 per cent). The dollar is therefore unlikely to lose its safe-haven status any time soon. Nor will its share of global reserves come down dramatically. The argument that there are no viable alternatives to the dollar is valid but the status of ‘reserve currency’ is won on its strength, and not on its being the best among poor choices. The rating downgrade has, of course, jolted treasury managers round the world out of their smugness and forced them to consider looking apart from the dollar. By risking a default, the U.S. political establishment has all but compromised the dollar’s once-unassailable position.