Why the Credit Rating of U.S. Treasury Bonds Does Not Fall
Published in Hong Kong Commercial Newspapers Company
(Hong Kong) on 11 February 2010
by Tsui Kwok Bun (link to original)
Why does the U.S. Treasury bond's credit rating not fall?
A comprehensive picture can only been seen in comparisons. Before the financial tsunami, the world was overheated by commodity speculation, and almost the whole world believed in the devaluation of U.S. currency. Upon the arrival of the financial crisis of the century, everybody realized that many established financial institutions could crumble overnight. The "invincible" financial modeling and derivatives suddenly failed to function; the so-called structural risk, which was previously only mentioned in literature, became real before our eyes. As a result, the whole world was simultaneously dumping assets, and only loved cash; and here cash refers to the U.S. dollar. To avoid risk, all capital flooded into U.S. Treasury bonds, just like before.
U.S. Dollar as Risk Shelter
Of course, after all central banks adopted extremely loose monetary policies as a last resort in the history of financial crises, the vicious cycle of the financial system was temporarily resolved, and funds flowed out of the U.S. Treasury and into the deeply discounted asset market in order to pick up cheap assets. Thus the U.S. dollar fell while other asset prices increased.
However, the recent European sovereign debt crisis made people realize that the U.S. dollar was the ultimate shelter for risk protection. The recent severe deficits and mounting debts of the Southern European countries sparked worries about their ability to repay these debts. As a result, capital flowed into the U.S. Treasury again; once again, the U.S. Treasury is the first choice as risk shelter. The U.S. dollar continues to rebound, while the prices of gold, stock, other foreign currencies and commodities are under downward pressure from their peak.
To make matters more complicated, the Euro is the common currency of most European nations; thus the fates of individual countries are now connected. In light of this, can the central and northern European countries ignore the financial hardship of their southern counterparts?
European Sovereign Crisis not as Severe as the Financial Tsunami
Of course, it is not easy to interfere. Historically, the Euro zone has displayed great caution in its reactions to inflation. In comparison, Europe’s monetary policy is not as loose as that of the U.S. However, with the onset of the financial tsunami, the Euro zone has been forced to loosen up.
It is an exaggeration to say that the current European sovereign debt crisis will lead to a very serious problem, especially when compared with the financial tsunami. They are two separate incidents. The financial crisis involved unpredictable volumes of financial derivatives, the prices of which could not be accurately evaluated since many firms went bankrupt, resulting in a vicious cycle. Comparatively speaking, the Greek sovereign debt crisis at the end of last year, and even the current European crisis, is not as severe as the financial tsunami.
Nevertheless, the current situation is pretty bad, especially in terms of fiscal pressure, which cannot be improved in a heartbeat. After the financial tsunami, the stimulus actions of all nations implied more borrowing, exchanging long term hardship for short term relief.
No Reliable Replacement at the Current Stage
One has to admire the U.S. Last week, some rating agencies indicated that the U.S. Treasury would be encountering pressure in its credit rating, unless measures were taken to reduce its federal deficit in the next ten years. The Treasury Secretary, Timothy Geither, immediately responded that no such thing would happen to the U.S. How can the Americans empower him to make such a comment?
The answer is mentioned above. During a crisis, everyone thinks of the U.S. dollar as a shelter. This historical phenomenon has its own basis, including the U.S.'s history of economic growth, creative entrepreneurship, rising productivity, talents and technological advances, etc., making it hard for other nations to compete. The main issue, as noted by the Israeli Central Bank Chairman, is that there is no replacement at the current moment.
However, China will reach the same stage with its continuous improvements in the above-named factors, such as growth, productivity, and so on. But even now, China has a long way to go, at least in terms of reforming and opening up its financial system.
In reality, for those who are pessimistic about the future of the U.S. dollar, the unanswered question is not the weakness of the U.S. currency, but why there is no suitable replacement for the dollar. As long as there is not a reliable replacement, it is impossible for the U.S. dollar to lose its leading position as the major global currency. With its unchallenged position, capital still floods into the U.S. Treasury during any emergency; this is a salient fact.
Over a Century to Replace the World Currency
In other words, as Geither said, the position of the U.S. dollar is not related to the measures taken by the Obama government: quite the contrary, it was an not a secret that “the U.S. dollar is not that strong, but other rivals are not good enough.”*
The more important question is: How long will it take its rivals to catch up? This is not hard to predict. Before World War II, the British Pound Sterling was the world's leading currency. After World War II, the U.S. dollar became the leader. That means it takes at least 50 to 100 years. Although the world is changing fast, it will take at least ten to twenty years for a new global currency to replace the U.S. dollar. Due to this long period of time, Timothy Geither can have the courage to say "absolutely not." It will not be his problem when it happens.
*Editor's note: I was unable to find the source of this quotation.
A comprehensive picture can only been seen in comparisons. Before the financial tsunami, the world was overheated by commodity speculation, and almost the whole world believed in the devaluation of U.S. currency. Upon the arrival of the financial crisis of the century, everybody realized that many established financial institutions could crumble overnight. The "invincible" financial modeling and derivatives suddenly failed to function; the so-called structural risk, which was previously only mentioned in literature, became real before our eyes. As a result, the whole world was simultaneously dumping assets, and only loved cash; and here cash refers to the U.S. dollar. To avoid risk, all capital flooded into U.S. Treasury bonds, just like before.
U.S. Dollar as Risk Shelter
Of course, after all central banks adopted extremely loose monetary policies as a last resort in the history of financial crises, the vicious cycle of the financial system was temporarily resolved, and funds flowed out of the U.S. Treasury and into the deeply discounted asset market in order to pick up cheap assets. Thus the U.S. dollar fell while other asset prices increased.
However, the recent European sovereign debt crisis made people realize that the U.S. dollar was the ultimate shelter for risk protection. The recent severe deficits and mounting debts of the Southern European countries sparked worries about their ability to repay these debts. As a result, capital flowed into the U.S. Treasury again; once again, the U.S. Treasury is the first choice as risk shelter. The U.S. dollar continues to rebound, while the prices of gold, stock, other foreign currencies and commodities are under downward pressure from their peak.
To make matters more complicated, the Euro is the common currency of most European nations; thus the fates of individual countries are now connected. In light of this, can the central and northern European countries ignore the financial hardship of their southern counterparts?
European Sovereign Crisis not as Severe as the Financial Tsunami
Of course, it is not easy to interfere. Historically, the Euro zone has displayed great caution in its reactions to inflation. In comparison, Europe’s monetary policy is not as loose as that of the U.S. However, with the onset of the financial tsunami, the Euro zone has been forced to loosen up.
It is an exaggeration to say that the current European sovereign debt crisis will lead to a very serious problem, especially when compared with the financial tsunami. They are two separate incidents. The financial crisis involved unpredictable volumes of financial derivatives, the prices of which could not be accurately evaluated since many firms went bankrupt, resulting in a vicious cycle. Comparatively speaking, the Greek sovereign debt crisis at the end of last year, and even the current European crisis, is not as severe as the financial tsunami.
Nevertheless, the current situation is pretty bad, especially in terms of fiscal pressure, which cannot be improved in a heartbeat. After the financial tsunami, the stimulus actions of all nations implied more borrowing, exchanging long term hardship for short term relief.
No Reliable Replacement at the Current Stage
One has to admire the U.S. Last week, some rating agencies indicated that the U.S. Treasury would be encountering pressure in its credit rating, unless measures were taken to reduce its federal deficit in the next ten years. The Treasury Secretary, Timothy Geither, immediately responded that no such thing would happen to the U.S. How can the Americans empower him to make such a comment?
The answer is mentioned above. During a crisis, everyone thinks of the U.S. dollar as a shelter. This historical phenomenon has its own basis, including the U.S.'s history of economic growth, creative entrepreneurship, rising productivity, talents and technological advances, etc., making it hard for other nations to compete. The main issue, as noted by the Israeli Central Bank Chairman, is that there is no replacement at the current moment.
However, China will reach the same stage with its continuous improvements in the above-named factors, such as growth, productivity, and so on. But even now, China has a long way to go, at least in terms of reforming and opening up its financial system.
In reality, for those who are pessimistic about the future of the U.S. dollar, the unanswered question is not the weakness of the U.S. currency, but why there is no suitable replacement for the dollar. As long as there is not a reliable replacement, it is impossible for the U.S. dollar to lose its leading position as the major global currency. With its unchallenged position, capital still floods into the U.S. Treasury during any emergency; this is a salient fact.
Over a Century to Replace the World Currency
In other words, as Geither said, the position of the U.S. dollar is not related to the measures taken by the Obama government: quite the contrary, it was an not a secret that “the U.S. dollar is not that strong, but other rivals are not good enough.”*
The more important question is: How long will it take its rivals to catch up? This is not hard to predict. Before World War II, the British Pound Sterling was the world's leading currency. After World War II, the U.S. dollar became the leader. That means it takes at least 50 to 100 years. Although the world is changing fast, it will take at least ten to twenty years for a new global currency to replace the U.S. dollar. Due to this long period of time, Timothy Geither can have the courage to say "absolutely not." It will not be his problem when it happens.
*Editor's note: I was unable to find the source of this quotation.