Column US ‘Exorbitant Privilege’ Alive and Well: McGeever by Reuters

By Jamie McGeever

ORLANDO, Florida (Reuters) – U.S. Treasuries may not be as risk-free as they once were, and the dollar’s grip on global foreign exchange reserves may have loosened, but talk of their demise remains extremely premature.

Policymakers, investors and even officials at the Fed’s Jackson Hole Symposium in Kansas City last week debated whether the pile of U.S. government debt threatens the country’s safe-haven status.

But America’s “exorbitant privilege”—that is, the US dollar’s status as the world’s reserve currency—continues to allow the US government to borrow staggering sums at relatively low cost.

And the fact remains that no other government debt market or currency comes close to rivaling the US Treasury and the dollar for liquidity and safety. It’s hard to see how this could change, meaning that the forecast of a US debt apocalypse and dollar collapse remains a distant prospect.

DANGER AHEAD?

That is not to completely dismiss concerns about the path of US fiscal policy.

Public debt is now around 100% of GDP and rising. It is expected to surpass the current record of 106 percent of GDP within three years, according to the nonpartisan Congressional Budget Office, and reach 122 percent of GDP by 2034.

This will equate to annual deficits of nearly $2 trillion, or nearly 7 percent of GDP, well above the 3.7 percent average seen over the past half century. You don’t have to be a “doomer” or even a gentle Cassandra to see warning signs here.

But this is where privilege comes in. Research published this week by Jason Choi of the University of Toronto, Rishabh Kirpalani and Duong Dang of the University of Wisconsin-Madison, and Diego Perez of New York University highlights the extent of America’s “exorbitant privilege.”

In their report “Exorbitant Privilege and US Public Debt Sustainability,” they note that this special status “increases the maximum sustainable debt by about 22 percent of GDP.”

In other words, the US government can sustainably borrow up to 22% of GDP more than it otherwise could if it were not the provider of the global reserve currency.

With US GDP currently hovering around the $27 trillion mark, that 22% equates to about $6 trillion in additional debt that Washington can sustainably issue at safe rates without significantly increasing the risk of default .

Most of this additional space is due to the “convenience yield” provided by the Treasury. In other words, investors benefit from Treasury liquidity and collateral use and are willing to accept lower yields as a result.

Today’s rate market seems to support this theory. The U.S. Treasury is currently borrowing record amounts — more than half a trillion dollars in notes and bonds this week alone — but yields along the curve are near their lowest levels this year.

UNATTACHABLE DOLLAR

With so much debt issued, is it fair to ask who will continue to buy and at what price? For much of the period between 2000 and 2020, foreign central banks were the main source of demand for Treasuries. That raised fears that the Treasury market could wobble if foreign central banks scaled back their purchases and holdings.

But these fears turned out to be unfounded. The share of foreign central banks declined, but private sector investors abroad, US domestic funds and the Fed itself filled the gap. The treasury market continues to function smoothly and act as a fundamental underpinning of the global financial system.

Similarly, there is little sign of a dollar collapse, which some of the more caffeinated analysts warned would inevitably come as central banks diversified their foreign reserves.

True, the greenback might currently be at a 2024 low, but turn back the clock a few years and it was at a 20-year high.

And even though it accounts for less than 60% of global reserves today, compared to more than 70% at the turn of the millennium, it is losing ground to small-cap currencies such as the Australian and Canadian dollars, the South Korean won and Nordic currencies, rather than the only its viable rival, the euro.

Nothing stays the same forever. Just ask Britain, whose currency dominated global markets for over a century only to be eclipsed by the greenback. But investors looking for safety, liquidity and safe returns will continue to put their faith in US Treasuries and the dollar – because, at least for now, there is no alternative.

(The opinions expressed here are those of the author, a Reuters columnist.)

(By Jamie McGeever; Editing by Andrea Ricci)