A few pundits pointed out yesterday’s rally in the stock market as a sign the government shutdown was not a big deal but the fact that the markets priced in that there would be no last minute deal Monday night and did not have a panic sell-off does not mean there is no damage.
We pointed out the contingency plan of the Commodity Futures Trading Commission (CFTC) and how that had to be replicated by countless government agencies. That could cause a problem and the mere fact that many of these agencies had to spend time devising such plans is an inefficient use of their time. Time we will pay for. Yesterday the CME Group pointed out one potential impact on some of their agricultural markets and today temporarily suspended the calculation and distribution of the CME Lean Hog and Feeder Cattle Indexes due to the unavailability of relevant data reported by the USDA-AMS.
Some of those pundits have even made the argument that the last shutdown, 17 years ago, resulted in some positive change like welfare reform and a balanced budget. I will let others argue that case but this is significantly different than the mid-1990s as Speaker of the House Newt Gingrich and President Bill Clinton where arguing over a budget. That is different than Congress refusing to pass a continuing budget resolution unless it can defund or delay a program that has already been passed into law.
As I mentioned in an interview with the Street.com yesterday, if the shutdown is resolved quickly it may not have a huge impact on the markets but it certainly will affect the economic numbers for the month of October if 800,000 people are out of work even for a few days. And we also are talking reputational damage. The United States does not look good in the eyes of the world when we have to shut down certain aspects of our government. I know there are people out there who do not believe the rest of the world matters but they are wrong. We trade with the rest of the world, the rest of the world buys a considerable amount of our debt and the rest of the world sees our currency as a safe haven. The dollar is not a safe haven just because we are America, but because we have proven to meet our obligations over the years.
This brings us to a potential larger problem. The big fight ahead, which really shouldn’t be a fight at all, will be over the debt ceiling. I pointed out two years ago in the futuresmag.com blog that despite a resolution to the debt limit debate, damage was done. CME Group increased margins in some financial products and increased the size of the haircut given to certain collateral users post as margin. While the CME was careful not to directly tie this to the debt limit debate saying it was based on a “normal review of market volatility,” that market volatility was certainly affected by even a slight possibility of a default.
The increased margins and haircuts meant capital that could have been used for other purposes was tied up. So it did have a negative impact on economic activity.
If Congress decides to play chicken with the debt ceiling again it could cause lasting damage on the U.S. economy. We noted how it could affect the U.S. dollar’s status as the world’s reserve currency.
This was a hot topic last year but most experts agreed that the dollar will remain the world’s reserve currency for several decades even with our current economic problems.
One expert, however, had a different take. Gold guru Jim Sinclair pointed out in an interview 18 months ago that the dollar has moved from a reserve currency of choice to a reserve currency by default and although its status as the world’s reserve currency will not change for some time, it is already becoming less important.
Sinclair said, “The dollar isn’t going to be replaced; [it] always will be there, but as far as a settlement currency; weekly, almost daily, you see the dollar mechanism for settlement being replaced by other currencies.”
He added, “There is a serendipitous but huge demand factor that a reserve currency enjoys as the settlement mechanism for international contracts. … Part of that demand factor will be going away as a result of utilization of other currencies.”
So reserve currency status is not a yes or no proposition, it can be a matter of degree. The dollar can lose a great deal of influence as a settlement mechanism and harm the Federal Reserve’s flexibility without being replaced.
A protracted battle over the debt ceiling that causes some institutions and governments to at least plan for a potential default scenario could push them to look for more alternative settlement mechanisms. This would lessen demand for dollars.