As the biggest economy in the world is being rocked by winds of shock and debt chaos, we all wonder where our fate lies. Questions have been springing from all directions on what our prospects are and if the future looks bleak. While there is a lot of controversy in American politics, I would like to, as a person, believe that we as a race are able to set aside our ideologies and face reality, deal with issues and handle them the way they deserve. There is very little cooperation between the American legislators and that kind of dichotomy is hurting the US Dollar; this is no time for Russian roulette; the US is gearing up to shoot itself in the foot and the whole world in the face. Last week I wrote briefly on the repercussions of US default and this week I’d like to reiterate and add some more points on this topic.
If the US defaults on its debt, the global banking and financial market liquidity could dry up. Lending between institutions and people or businesses could possibly cease altogether or become cost prohibitive. Further, the US government will effectively start to run out of money to pay civil servants, government contractors, pensioners or holders of government debt. The shock would quickly spread throughout the world and would very likely lead to a serious global recession, possibly worse than the one seen a few years ago. The risk appetite of investors has been dented and rating agencies have warned of potential downgrade over the past weeks. Some of the fear arising now on the US defaulting on its debt could hoist interest rates, weaken the dollar and erode the dollar's reserve currency status.
As the dollar gets weaker, US exports get cheaper and our exports to the US get expensive. With a weak dollar, the oil exporters adjust their dollar prices upward to compensate, thereby forcing oil importers (like us) to bear higher energy costs and suffer the resultant rise in the prices of energy-dependent products and services. As the prices of oil rise, most commodity prices will raise leading to reduction of real incomes. When real incomes drop, consumers start to reduce consumption of luxury goods such as diamonds and the fact that our prices in the US then become expensive does not help our case. As Botswana from this we face another deficit in the balance of payments like that during the 2008 crisis.
The US dollar has always had the privilege of being the sole reserve currency in the world which meant that USA has been the only country with no foreign exchange risk when buying back its debt as it never faces the problem of an increase in foreign debt as the value of its currency declines. Most countries have their reserves in US Dollars and are worried that the continued weakening of the dollar may cause losses in their foreign reserves which cannot be offset by other overseas investment earnings. The big developing countries, those referred to as the BRICS countries (Brazil, Russia, India, China and South Africa), are making some effort to protect them from what they see as steady erosion in the value of the American currency; in a summit of the BRICS in Hainan recently, they agreed to make trade settlements with each other in their own currencies and not in US dollars. They also announced, “We support the reform and improvement of the international monetary system, with a broad-based international reserve currency system providing stability and certainty.”
The support to the international monetary system reform should become widespread after this turmoil; countries should follow on the path of the BRICS, encourage trade in other currency and most importantly diversify markets; reliance on one major economy creates instability. It will take a long time for the US Dollar to lose its sole reserve currency and the repercussions of the Dollar not being the centre of the world could introduce radical change to the lifestyles for both those in the US and other countries particularly those with currencies pegged to the Dollar, large foreign reserves and those receiving aid from the US while European and African countries who have loans in US Dollars will enjoy lower debt.
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