June 25, 2024

During a weekly breakfast among friends the persistent US budget deficits and the rise in the debt to GDP ratio became a topic of discussion. Within a few minutes it became clear that the main worry was whether the US could reach a point where the debt service becomes unsustainable and results in a sovereign financial crisis. Under this scenario the crisis would be a self-inflicted wound. A related topic was the possibility that the rest of the world central banks cease holding US dollar securities. If our adversaries successfully dethrone the US as the reserve currency country, RCC, the global demand for US bonds could decline abruptly fueling a sovereign debt and dollar crisis. How would we know and what do the warnings signs tell us ? Looking at US data , it is apparent that current levels of the indicators do not match the conditions that lead to a sovereign debt crisis. The foreign exchange value of the dollar has risen steadily since the financial crisis. The interest rates are not out of line with the historical norms. There is no recession in sight. More importantly during recent crises, the fixed income market has experienced a “flight to quality” where the US dollar and bond prices have temporarily increased, the result being the opposite of what would happen during a sovereign debt crisis. The data does not support the view that a dethroning of the US as an RCC is imminent.

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