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Tags: Eichengreen | dollar | US | currency

UC Berkeley's Eichengreen: Washington Standoff May Mean End of Dollar as Top Currency

By    |   Monday, 14 October 2013 10:20 AM EDT

The federal standoff over the debt ceiling limit and possible government default may spell the end of dollar's role as the world's top currency.

If Congress refuses to raise the debt ceiling and the government defaults — or even skirts with default — investors will lose faith in Treasury bonds and head to other currencies. The dollar would lose its status as the main global currency.

The U.S. economy might lose 2 percent of GDP a year if that happens, estimates Barry Eichengreen, a professor of economics and political science at the University of California, Berkeley, in an article for Project Syndicate. The government would pay more to borrow, and Treasurys would also lose their safe-haven status.

Editor’s Note:
Opinion: Retirees to Be Hit With Social Security Cuts

"Sane governments do not default when they have a choice — especially not when they enjoy the 'exorbitant privilege of issuing the only true global currency," Eichengreen notes. "We are about to find out whether the U.S. still has a sane government."

Financial markets would freeze up if the government defaults, he predicts.

Because Fedwire, the Federal Reserve's electronic network that transfers funds between financial institutions, cannot settle transactions in defaulted securities, it would immediatly freeze, says Eichengreen, a former senior policy adviser at the International Monetary Fund and author of "Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System."

"The repo market, in which loans are provided against Treasury bonds, would also seize up," he maintains. "For their part, mutual funds that are prohibited by covenant from holding defaulted securities would have to dump their Treasurys in a self-destructive fire sale.

The entire commercial banking sector would be threatened, and even the FDIC might go bust if the value of banks' Treasury bonds sunk.

"The impact on the rest of the world would be even more calamitous," he argues.

Investors would turn to other currencies like the euro, a horrible prospect for eurozone countries that desperately need to increase exports. Currencies like the Canadian dollar and Norwegian krone, even currencies of emerging market countries, would "shoot through the roof."

Even advanced countries might have to institute strict capital controls. That would mean the end of financial globalization, even all economic globalization, he states.

Some experts fear a string of American political standoffs is already prompting investors, especially foreign investors, to lose faith in U.S. debt.

"It's only marginal for now. But over time, the political problems will undermine the willingness of international investors to buy U.S. dollars and dollar-denominated assets. What's happening in Washington is happening too frequently," Andrew Milligan, head of global strategy for Standard Life Investments in Edinburgh, Scotland, tells CNNMoney.

Editor’s Note: Opinion: Retirees to Be Hit With Social Security Cuts

Related Stories:

Bove: US Debt Default Would Spark 'Devastating' Depression

Treasury Says Default Has Potential to Be Catastrophic

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InvestingAnalysis
The federal standoff over the debt ceiling limit and possible government default may spell the end of dollar's role as the world's top currency, says Barry Eichengreen, a professor of economics and political science at the University of California, Berkeley, in an article for Project Syndicate.
Eichengreen,dollar,US,currency
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2013-20-14
Monday, 14 October 2013 10:20 AM
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