US ‘Exorbitant Privilege’ Remains Strong: McGeever

By Jamie McGeever

ORLANDO, Florida – While U.S. Treasuries may no longer be perceived as completely risk-free and the dollar’s dominance in global currency reserves appears to be weakening, discussions about their imminent decline are still very premature.

Debates among politicians, investors, and attendees at the recent Kansas City Fed’s Jackson Hole Symposium centered on whether the escalating U.S. government debt poses a threat to the country’s status as a safe-haven.

Despite these concerns, the notion of America’s ‘exorbitant privilege’—the U.S. dollar’s position as the world’s reserve currency—continues to empower the U.S. government to borrow substantial amounts at relatively low interest rates.

No other government debt market or currency comes close to matching U.S. Treasuries and the dollar in terms of liquidity and safety, making a catastrophic event like a U.S. debt or dollar collapse unlikely in the near future.

WARNING SIGNS?

This isn’t to dismiss entirely the worries surrounding U.S. fiscal policy. Current public debt stands at approximately 100% of GDP and is projected to exceed the existing record of 106% within three years, reaching 122% by 2034, as indicated by the Congressional Budget Office.

Such levels could lead to annual deficits approaching $2 trillion, or nearly 7% of GDP, significantly higher than the 3.7% average seen over the past fifty years. One doesn’t need to be overly pessimistic to recognize these warning signs.

However, this is where the aforementioned privilege plays a role. Recent research highlights the magnitude of America’s special status. According to a report, this unique standing allows for an increase in sustainable debt by about 22% of GDP.

This means that the U.S. government can afford to borrow an extra $6 trillion sustainably at safe interest rates, thanks to its status as the provider of the global reserve currency.

Much of this additional capacity is attributable to the ‘convenience yield’ offered by Treasuries; investors prize the liquidity and collateral usability of these securities, often accepting lower yields in return.

Current market dynamics seem to corroborate this viewpoint. The U.S. Treasury is issuing record amounts of debt—over half a trillion dollars in bills and bonds this week—yet interest rates remain at some of their lowest levels this year.

STRENGTH OF THE DOLLAR

Given the vast amounts of debt being issued, questions arise about ongoing demand and pricing. Between 2000 and 2020, foreign central banks were the main purchasers of Treasuries. Concerns surfaced regarding the stability of the Treasury market if these entities reduced their holdings.

However, those concerns have proven largely unfounded. While the share held by foreign central banks has diminished, private investors from abroad, U.S. domestic funds, and the Federal Reserve have compensated for this change. The Treasury market continues to operate smoothly and remains a foundational pillar of the global financial system.

Furthermore, worries about a potential collapse of the dollar—a forecast from some analysts—seem exaggerated. While the dollar is at a recent low compared to earlier forecasts, it had surged to a 20-year high just a couple of years ago.

Though the dollar comprises less than 60% of global reserves today compared to over 70% at the beginning of the century, it continues to lose ground primarily to currencies with minimal shares, rather than to its main competitor, the euro.

Nothing remains constant forever; history teaches us that currencies can rise and fall in prominence, as seen in the past century with the British pound. Nevertheless, investors seeking security, liquidity, and reliable returns are likely to maintain their confidence in U.S. Treasuries and the dollar—at least for the time being, as no viable alternatives have emerged.

(The views expressed in this article are those of the author, a columnist for Reuters.)