A dollar aint a dollar anymore

Written by K Vaidya Nathan | K Vaidya Nathan | Updated: Oct 8 2013, 08:20am hrs
There are a lot of Obama jokes floating around in the US these days about the government shutdown and how the President would now have to reduce the White House cleaning staff and wash his own laundry and to stretch it a little further, clean his toilets as well. While everybody in social circles is talking about the shutdown, there is lack of media coverage on how concerned the average American is about the shutdown snowballing into a major crisis. The media coverage is pretty much centred around which senator said what, without any alarm or analysis about the stalemate precipitating into a default crises.

Most of the mainstream newspapers here have a coverage of the event which almost seems like government propaganda. Virtually all commentators are unanimous in their view that excessive government spending is not a problem and argue that the US Congress is being hyperbolic in not raising the countrys debt ceiling. They seem to suggest that if the lender does not have a problem lending, then why should the good borrower worry about debt ceilings. For example, an article by media outlet Reuters claims that, default or not, Asian investors and central banks are hostage to US debt (http://goo.gl/EHZvZT). Their argument essentially revolves around the delusional notion that Asian investors believe an American default to be unthinkable. In the article, Reuters peddles its theory based on an unnamed Japanese investment source (an insider), as if it truly represents the whole of Asia!

The reality is that Asia and China, in particular, have been preparing for a loss of confidence in the US Treasury market for quite some time now. Think about Asian central banks significant gold purchases and diversification away from US Treasury. Most central banks in Asia have converted their long-term bond holdings in US Treasuries to short-term bond holdings; meaning, they are ready to liquidate their bonds if need be. The strategic importance of the US paper has been coming down over the years and it is no longer considered risk-free. Overall purchase levels of Treasuries for Asian countries are either static, or falling depending on the nation involved.

Of late, the rupee has been experiencing a lot of volatility against the dollar, so it is not the best currency to benchmark against. But if you were to consider the value of dollar against other Asian currencies, the greenback has been in a continuous decline. For instance, the Singapore dollar has appreciated nearly 25% from 1.55 levels two years back to 1.25 level as of now. The Chinese Yuan was more than 6.8 vis vis US dollar couple of years back. Currently, it is at 6.12 levels. Not just that, China has been internationalising its currency and has opened Yuan clearing houses in multiple countries to allow faster convertibility of the Yuan, quietly supplanting the dollar as the world reserve currency. These clearing houses now exist in London, Hong Kong, Singapore, Taiwan, and even Kenya. International banks like my former employer, JP Morgan, are heavily involved in the internationalisation of the Yuan.

The assertion that Asia is somehow hostage to US debt is self-indulgence at best and self-exaltation at worst. In truth, its the other way aroundthe US economy is hostage to Asian holdings of US debt. Asian economies are not going to sit back and do nothing while their investment in US debt quickly disintegrates. A call for a dump of US treasury bonds by China, for example, in the face of a prolonged shutdown, would immediately result in a global chain reaction ending in the destruction of the dollar as the world reserve currency. This is not a remote possibility any more, but a mathematical deduction based on long-term trends.

If the shutdown stretches for long, not only would Americas borrowing capacity get crippled, life within the country would change for the worse. There will be cuts in all support programs and entitlements like social security, Medicare, employee pensions, even the Postal Service which has been receiving its own brand of bailout in the form of quiet cash infusions from the federal government. Even schools and parks that receive federal aid will discover immediate cash-crunch. Unlike that in India, an enormous subsection of the American public life is dependent on federal money. If that money dries up, Indian style government-free way of life will ensue. I dont like the idea, at least till such time I am here, but it is a possibility.

If the gridlock continues, I have little doubt that the US economy will experience a crisis. Sadly, an extended government shutdown is a sizeable threat to the American financial system, and the mainstream media doesnt seem to get it or perhaps chooses to look the other way. Undermining risk is neither sound public policy not informed public debate. It is far better for the mainstream media to bring the risks out in the open however disagreeable or discomforting than to ply government hoopla, however palatable or pleasing.

The author, formerly with JPMorganChases Global Capital Markets, trains finance professionals on derivatives and risk management