Rising Debt and US Brinkmanship Are Top Risks to USD

   2023-05-05 04:05

  • De-dollarization fears are overblown, and the greenback remains strong globally, BofA said.
  • But the main risks to the dollar are rising US debt and “fiscal brinkmanship,” according to a note.
  • “Therefore, the key threats to the USD’s dominant role seem largely domestic, as opposed to competition from other currencies.”

The greenback’s reign won’t be nearing its end anytime soon as de-dollarization headlines are exaggerations, Bank of America said in a Thursday note.

Instead, the dollar is more at threat from domestic fiscal issues, especially with the US at risk of falling into its first default.

“Because much of the USD’s dominant role comes from standing in front of the TSY market, surprise defaults from a debt ceiling showdown would compromise the dollar’s attractiveness as a store of value,” BofA wrote. “Therefore, the key threats to the USD’s dominant role seem largely domestic, as opposed to competition from other currencies.”

While the analysts said the dollar will not lose its “exorbitant privilege,” the long-term risk to the greenback is complacency about debts.

The note pointed out that US government debt is the highest in G10 as a share of GDP, except of Japan, and the IMF expects the debt-to-GDP ratio to climb to 136% by 2028 from 122% in 2022.

In addition, “US fiscal brinkmanship, with risks for government shutdown, or even worse a default, keeps coming up during debt ceiling discussions,” BofA added.

Republicans in Congress are demanding steep spending cuts in return for an increase in the debt ceiling, while the White House has refused to allow any conditions. Both sides remain deadlocked even as the government could default as soon as June 1.

Amid the looming risk of default, BofA said there are no real alternative currencies, even as others have also pointed to a rise in non-dollar arrangements as evidence of de-dollarization.

While the dollar has lost some market share among central bank reserves, it remains dominant in trade, international invoicing, and SWIFT payments, analysts added.

Though the yuan does have the potential to grow internationally, Chinese regulators who currently control its level would need to open its capital account, something that could leave China vulnerable to outflow volatility and monetary policy interference, according to the note.

A BRICS currency is also unlikely, given that it would rely on cooperation between members who don’t trade much with each other beyond China, and whose relationships can often be tense.

Meanwhile, stablecoins are the only digital asset that could disrupt currency trends, though they are impaired by unclear legislative frameworks. But if developed further, a dollar-backed cryptocurrency could actually strengthen the dollar’s position, BofA said.

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