Market Analysis

U.S. Treasuries may no longer be the bastion of safety they once were, and the dominance of the dollar in global currency reserves might have weakened somewhat, but predictions of their downfall remain highly exaggerated.

Recent discussions among politicians, investors, and even officials at the Kansas City Fed's Jackson Hole Symposium have centered on whether the rapidly increasing U.S. government debt is jeopardizing the nation's safe-haven status.

Yet, the U.S. still enjoys its 'exorbitant privilege' – the status of the dollar as the world's reserve currency – which continues to allow the U.S. government to borrow vast sums at relatively low interest rates.

The reality is that no other government debt market or currency can match U.S. Treasuries and the dollar in terms of liquidity and safety. It's difficult to envision a scenario where this changes, making the dire predictions of a U.S. debt and dollar crisis seem far off.

Is There Cause for Concern?

This is not to say that concerns about U.S. fiscal policy should be ignored.

Public debt is now hovering around 100% of GDP and is on an upward trajectory. The non-partisan Congressional Budget Office projects it will surpass the current record of 106% within three years and reach 122% by 2034.

This would result in annual deficits of nearly $2 trillion, or close to 7% of GDP, well above the historical average of 3.7% over the past 50 years. You don’t have to be overly pessimistic to see potential risks on the horizon.

However, this is where the U.S.'s unique advantage comes into play. A recent study by researchers from the University of Toronto, University of Wisconsin-Madison, and New York University underscores the extent of America's 'exorbitant privilege.'

Their report, "Exorbitant Privilege and the Sustainability of U.S. Public Debt," suggests that this special status allows the U.S. to sustainably borrow an additional 22% of GDP more than it would be able to without the dollar's reserve currency status.

With U.S. GDP around $27 trillion, this 22% translates to roughly $6 trillion in additional debt that Washington can issue at safe rates without significantly raising the risk of default.

A significant portion of this borrowing capacity comes from the 'convenience yield' offered by Treasuries. In other words, investors value Treasuries for their liquidity and use as collateral, which allows the U.S. to offer lower yields.

Current market conditions support this theory. Despite the Treasury issuing record amounts – more than half a trillion dollars in bills and bonds this week alone – yields across the curve remain near their lowest levels of the year.

The Dollar's Unshakeable Position

Given the sheer volume of debt being issued, it's reasonable to question who will continue to buy and at what cost. Between 2000 and 2020, foreign central banks were the primary buyers of Treasuries, leading to fears that a reduction in their purchases could destabilize the market.

However, these concerns have proven unfounded. Although foreign central banks have reduced their share, private sector investors from overseas, domestic U.S. funds, and the Federal Reserve have stepped in to fill the gap. The Treasury market remains robust and continues to serve as a cornerstone of the global financial system.

Similarly, fears of a dollar collapse as central banks diversify their foreign exchange reserves have not materialized. While the dollar is currently at a 2024 low, it was at a 20-year high just a few years ago.

Though its share of global reserves has fallen below 60%, down from over 70% at the turn of the millennium, the dollar is losing ground to currencies with minimal shares, such as the Australian and Canadian dollars, South Korean won, and Nordic currencies, rather than its main rival, the euro.

Change is inevitable – just ask the UK, whose currency once dominated global markets before being overtaken by the dollar. However, for now, investors seeking security, liquidity, and safe returns will likely continue to trust U.S. Treasuries and the dollar – because, for the moment, there is no viable alternative.

Paraphrasing text from "Reuters" all rights reserved by the original author.