U.S. Debt Negotiation Impasse Sets Off Crisis of Confidence

The slowly progressing debt ceiling negotiation in the U.S. is so painful that even the stubborn U.S. dollar has begun to surrender. In the past two days, the exchange rate of the Swiss franc, Japanese yen, South Korean won, Australian dollar and Malaysian ringgit against the U.S. dollar have all increased to their highest level compared to months or years ago, or even in history.

Analysts point out that the short-term trend of the U.S. dollar will depend on the progress of the U.S. debt ceiling negotiations, and they will not rule out a compromise that would exceed the market’s expectation and push the U.S. dollar to a short-term rebound. However, from a long-term perspective, the fundamentals of the U.S. dollar are still not very optimistic, and disputes over the current debt ceiling have just sounded a risky alarm to shareholders of U.S. dollar assets. The U.S. dollar’s short-term volatility and long-term weakness continue to strike against the global market and world economy through channels such as the currency market and commodities.

U.S. Dollar Suffered Total Loss against Major Currencies

Up until this Tuesday, the U.S. dollar did not appear to be heading in any unusual direction, although the debt ceiling negotiation was full of twists and turns. Even the great fall in the second half of last week was mainly the seesaw effect of the huge increase in the Euro. But, since the U.S. government is approaching the Aug. 2 deadline for default, the U.S. dollar began to decline in the past two days. It has suddenly lost the appeal as a safe haven that it enjoyed exclusively during past storms.

In late trading in Asia on Aug. 27, the U.S. dollar index fell to 73.42 at one time and reached its lowest level since May 5. The day before, the U.S. dollar index fell 0.8 percent.

Against the performances of each major currency, the U.S. dollar also appears to be falling generally. It reached a new historical low against the Swiss franc this week, and even for the first time fell 0.8 percent during trading on Aug. 27. Both the Australian and New Zealand dollars reached a 30-year high against the U.S. dollar this past Wednesday; AUD against the dollar even broke through the 1.1 level. The Dollar again fell 0.3 percent against the Japanese yen on the 27th and reached 77.57, creating a new low since the G7 jointly intervened in the Japanese yen in mid-March.

In Asia, where economic growth is relatively strong, local currencies’ rally against the U.S. dollar is even more focused and clear. An index that covers the 10 most active currencies in Asia (except the Japanese yen) continued to increase in the past two days and came close to the 14-year high. Singapore’s yuen, Malaysia’s ringgit, South Korea’s won and Indonesia’s rupiah all went up. China’s renminbi also reached a new high. The most recent statistic from China’s Foreign Exchange Trading Center indicated that the median price of the exchange rate for renminbi against the U.S. dollar was 6.4426 on the 27th — a new high on the second trading day in a row since the reform of the exchange rate.

The sudden accelerating fall of the U.S. dollar began to draw strong attention from investors of U.S. dollar assets. Some signs indicated that it was being shrouded in the shadow of the debt crisis. The U.S. dollar as a halo of the safest assets has begun to weaken.

The Philippines’ Treasury Secretary Purisima indicated this week that the U.S. has not been able to reach a debt agreement as quickly as possible, which has led people to lose their confidence in the U.S. dollar. This may also encourage people to hasten the search for an alternative reserve currency. Purisima said that the Philippines has been doing the best it can to get ready for any possible turbulence caused by the U.S. The Philippines’ reserve has reached 69 billion and, as with many other countries, most of it is in U.S. bonds.

A strategist from HSBC Holdings thought that the currency market trend over the past two days demonstrated that in contrast to previous situations, many U.S. dollar assets such as U.S. bonds have become risky assets that investors have raced to avoid.

Debt Ceiling Situation Will Cause Long-term Suppression of U.S. Dollars

The negotiations surrounding the debt ceiling are no doubt the main factor affecting the dollar right now; however, this fight between the White House and Congress, described as a “political game” by Obama, has so far left no indication that any important progress has been achieved.

On Tuesday, a proposal that included deficit reduction and a debt ceiling increase, presented by Republican leader John Boehner in the U.S. House, was delayed for voting because it was opposed by the party and had to be modified urgently. Then, on the Democrats’ side, a proposal that includes a long term debt ceiling increase, presented by Democrats including Senate Majority Leader Harry Reid, has been advancing, and has now obtained support from the White House.

However, Congress does not hold out too much hope for the passing of the two proposals. The White House and Congress ultimately may have no choice but to consider alternate programs to avoid default.

Nowadays, many people in the currency industry have a more pessimistic outlook about the U.S. dollar. Worst-case scenario: If no agreement is reached and the U.S. is led to default, then the U.S. dollar will become weaker. Even if both parties reluctantly reach a compromise agreement, the dollar will still face the risk of being downgraded by rating agencies, and this will further impact the U.S. dollar.

More and more agencies and market experts believe that even if the U.S. debt ceiling can be increased at the last minute, the U.S. AAA rating will probably still face risk if the U.S. cannot present a long-term plan that includes huge deficit reduction

“We think that Standard and Poor’s will downgrade the U.S. rating,” Paribas pointed out in a report on Tuesday. It also speculated that “the news of downgrade will lead to more shock, meaning that the U.S. dollar will fall further in a knee-jerk way.”

Christopher Molumphy, Franklin Templeton Fixed Income Group's chief investment officer, wrote in an email sent out to reporters on Wednesday that even if the U.S. can survive this crisis, investors will still question the country’s credit. He thought that the market’s continuing concerns about the lack of a long-term resolution that is capable of reducing financial deficit, may threaten the U.S. credit rating and the U.S. bond’s status as a “no-risk asset.”

Fuel Commodities and Push-up Inflation

Of course, some people have a more optimistic point of view. The foreign exchange strategist at Citigroup said that leveraged investors are already emptying out the U.S. dollar. Therefore, if new events accelerate cooling on risk appetite and uncertainty, then the market’s subconscious reaction will be to go the other direction and buy more of the U.S. dollar.

Analysts think that because the U.S. is unstable in the short run due to the debt issue, and given predicable declining tendencies in the long run, wide impact will be felt in the global market and economy.

These days the economic decision makers who most directly feel such impact are those from countries such as Brazil, South Korea, Japan and Thailand. Brazil, whose currency has reached a new 10-year high, warned again that it will adopt new intervention measures. And in Asia, traders noticed that as currencies like South Korea’s won, Thailand’s baht and the Philippines’ peso all fell to or close to the level before the financial crisis, these countries’ central banks stepped in and intervened in the currency markets.

Caused by the fall of the U.S. dollar, other related countries’ currencies increased, and the biggest impact could be seen in exports. The data released on Aug. 27 indicated that South Korea’s GDP growth slowed to 0.8 percent in the second quarter, and export was the biggest encumbrance. The won against the dollar has currently reached a three-year high. In Japan, stocks of companies in the export sector, such as Nissan, led the fall in trading on Wednesday. This reflected negative trading because of the rapid acceleration of the Japanese yen against the U.S. dollar.

Another big impact, felt especially by newly emerging economies, is the U.S. dollar’s indirect influence on the commodities market. The U.S. dollar increased pressure on imported inflation in emerging markets, and as the dollar again continued to fall, commodities have been quietly regaining the favor of large organizations and speculators. Gold, silver and crude oil have become leaders; gold reached a new high and broke through $1,620 per ounce this week, while the price of crude oil again returned to $100 a barrel.

Statistical data showed that recently international organizations went all out and bet that the price of goods would go up. Bloomberg’s data indicated that during the week of July 19, speculators’ net long positions focused on 18 types of commodities increased 16 percent and made the biggest gain since August of last year. Fund tracking and research agency EPFR’s data indicated that in July big commodities swept away the second quarter slump and became the most attractive target pursued by investors.

Market experts said that the instability caused by the debt crisis made hard merchandise such as gold, silver and oil alternative options for investment. At the same time, as the international pricing currency, the weakened U.S. dollar also helped push up the prices for merchandise.