Editor’s Note: Dr. Dan Steinbock is Research Director of International Business at the India, China and America Institute in the U.S. and Visiting Fellow at the Shanghai Institutes for International Studies in China.
By Dan Steinbock – Special to CNN
Lawmakers just closed on a $3 trillion deal, which will raise the U.S. debt limit by $1 trillion and avoid default. However, it is less likely to deter the downgrading of America’s credit rating in the near future. Indeed, today’s debt deal could well herald a dramatic transition - the end of triple-A stability in the advanced economies.
Exiting from U.S. Markets?
The Washington stalemate over the debt has been remarkable, particularly given that foreign nations fund almost half of the U.S. budget deficit. While unlikely, a sudden rush for the exit from U.S. Treasuries cannot be ruled out completely. What if foreign holders disinvest their Treasuries? Here are three possibilities:
1. In the sudden withdrawal scenario, the price of U.S. Treasuries would plunge in U.S. securities markets. Conversely, the market rate of interest would climb. The dollar would fall in value relative to other currencies.
2. In the diversification scenario, foreign investors would seek to diversify the composition of their portfolios by replacing a significant share of their holdings of U.S. Treasuries with other dollar-denominated assets. The price of the Treasuries would decline and the prices of other assets would rise.
3. In the shift away from dollar-denominated assets scenario, foreign investors would try to pare down their holdings of dollar-denominated assets through a liquidation of part or all of their holdings of dollar-denominated assets, possibly even direct investments (in U.S. businesses and real estate), either slowly or rapidly.
Last May, the grand total of foreign holders amounted to more than $4.5 trillion. While international speculation over withdrawal scenarios tends to focus on the role of China, which holds 26% of that foreign total, non-Chinese interests account for 74% of the foreign holders’ total.
These foreign holders of American debt include Japan (20%), UK (8%), oil exporters (5%), Brazil (5%) and Russia (3%). Many – including Japan, UK, Ireland, Italy, and France – have substantial debt problems of their own.
In Japan, gross debt exceeds 210% of GDP. In UK, growth is stagnating. Ireland has already been bailed out once. With its huge EUR 1.6 trillion of debt, Italy is dependent on investors’ confidence to keep its interest payments low. And recently, the IMF warned that even France’s economic prospects are clouded by a challenging external environment.
In the foreseeable future, then, it is only prudent for the leading emerging powers to continue gradual diversification and incremental moves toward alternative assets.
The End of the Triple-A Stability
Over the past two decades, the erosion of the fiscal positions of the most advanced economies has been spectacular. In the early 1990s, the share of countries, which had government deficits of 10% or more of GDP, was close to zero percent of global GDP. Today, such countries account for half of global GDP.
Due to the debt and default problems in the leading advanced economies (Eurozone, the United States, and Japan), and overheating in the large emerging economies (China, India, Brazil, Russia), growth is about to slow while uncertainty is increasing.
The aggregate domestic market capitalization of regulated exchanges around the world tells the story. In April, stock markets worldwide soared to $59.2 trillion; since then, markets have lost more than $2.6 trillion.
During the past two decades, we have been moving closer to a position where there may no longer be a risk-free security (that is, free of default risk and/or with a safe real rate of return) – anywhere in the world.
The good news is that the sovereign debt of some leading emerging market economies could soon be safer than that of any of the G7 countries.
The U.S. deficit deal heralds the emergence of a new multipolar world – one that is driven by emerging and developing economies, not by advanced economies.
At the end, the world economy and risk will be more diversified. But the process will be anything but smooth.
The views expressed in this article are solely those of Dan Steinbock.