Moneycontrol Pro Panorama | America’s problems shouldn’t be the world’s headache

A US recession hurts emerging market economies more through a slowdown in exports.

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US President Richard Nixon’s treasury secretary John Connally’s iconic statement in 1971, “the dollar is our currency, but your problem” can be stretched to other metrics of the country. A US financial meltdown spread fast to the rest of the world in 2008 and affected every country. A US recession hurts emerging market economies more through a slowdown in exports. An American consumer needs to continue consumption for Asian factories to keep chugging.

Every time America has winced, the world has felt the pain. The latest downgrade in its sovereign rating is no exception. Global rating agency Fitch’s downgrade of US sovereign rating is logical in the face of the government’s borrowing binge. Fitch has pointed out the weakening governance enumerated by the innumerable occasions of debt ceiling hikes and the simultaneous increase of the sovereign debt pile to the mountain of $31 trillion today. Our Chart of the Day details the instances of ceiling hike (78 times since 1917) and the fact that US accounts for nearly 10 percent of global debt.

Fitch’s worries are not unfounded despite the umbrage that the questioning of US’s creditworthiness has evoked. In fact, the reservations on rating are even more serious, given that this is not the first time the US has been downgraded. As Ananya Roy points out in her column for us here, S&P’s rating cut came in 2011 and the reasons were eerily similar. The upshot is that the US has continued its fiscal profligacy with impunity.

Any other country, especially a developing one, indulging in such an adventure would have paid a hefty price and history shows many examples of the same. What made the US different is that it can print dollars anytime to get out of a tight spot, and a big chunk of its debt is funded by foreign investors. Markets believe this would continue and that explains the S&P 500’s rather lukewarm response to the rating downgrade. The general view is that this movie has played out before and we know how it ends.

That brings us to what the markets are getting wrong this time. There is a distinct difference this time. The US Federal Reserve cannot print money without consequences. Basic economics shows that money printing leads to inflation. In the past decades, US inflation has been conspicuously absent or hardly ever more than the 2 percent target. That gave policymakers enough ammunition to crank up the printer whenever necessary. That luxury is now gone with inflation around 3 percent for which the Fed had to hike its rates by an unprecedented 5 percentage points. The other luxury of foreign buyers is also less dependable now. The US could build up its debt as foreign investors including central banks across the world loaded up on US treasuries. Foreign investors held 11 percent of US debt in 1972 which doubled to 22 percent by 2002. The two decades that followed saw the share go up only marginally to 24 percent. Ace investor Mark Mobius said in this interview with us that the rating downgrade is a good opportunity for investors to diversify their holdings away from the dollar. Central banks are already doing that.

The link that transmits the troubles of Washington onto others is the dollar. The dollar’s hegemony continues and the recent signs of resilience of the US economy are good news for it. This only strengthens the case for US market valuations.

The move away from the dollar is a long-drawn process rife with political motivations and economic traps. But it is perhaps the only way to make America own her problems. Until then, the rest of us will suffer the symptoms.

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Technical Picks: Zomato, ITC, Laurus Labs, SBI and Lead (These are published every trading day before markets open and can be read on the app).

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Aparna Iyer
Moneycontrol Pro