The U.S. dollar as the world's reserve currency has taken a couple of body blows recently, including the Federal government shutdown and the possibility that failing to increase the debt ceiling in October could cause the U.S. government to default on its debts. Is it any wonder that the U.S. dollar index is falling amidst all the drama?
While it has been 17 years since the federal government shut down over a budget impasse, it's just been a little more than two years since the debt ceiling limit impacted the credit worthiness of the U.S. government. In August 2011, the debate over raising the debt ceiling convinced one credit rating agency, Standard & Poor's, to lower the U.S. government's credit rating from AAA to AA+ with a negative outlook on the long-term rating. Congress had just passed a bill increasing the debt ceiling. A second rating agency, Egan-Jones Ratings Co., had posted a similar downgrade weeks prior to passage of the debt-ceiling bill.
Debt issued by the U.S. Treasury carries the full faith and credit backing of the United States government. What happens if the government chooses not to honor that pledge? Let's hope we don't find out.
An unexpected outcome in the 2011 downgrade is that U.S. Treasury securities actually reacted to the ratings announcement by going up in price (down in yield). You would expect investors would want to sell off their Treasuries and that yields would have gone higher.
In times of economic or government uncertainty abroad, U.S. Treasury securities typically experience higher prices and lower yields in what's called a "flight to quality." That happened in August 2011, even though the bad news -- a credit downgrade -- was happening to the U.S. government.
Will it happen again? No one knows for sure, but the weakness of the dollar points to money flows out of the dollar and into other currencies. The British pound and the euro are both at or near highs for the year against the dollar. Even the Japanese yen is strengthening in the midst of this U.S. crisis, and the Japanese are actively trying to weaken their currency. Of course in 2011, the debt ceiling was raised, and the issue was the credit downgrade. The federal government gazed into the abyss but didn't free fall into defaulting on its debt.
What do you think? Will, after a bit of brinkmanship, Congress and the president show good judgment this time around?
Dr. Don Taylor, in addition to answering our readers' questions about personal finance, is an assistant professor of business administration at Penn State Brandywine in Media, Pa. He holds a doctorate in finance and has earned both master's and bachelor's degrees in finance. To ask a question of Dr. Don, go to the "Ask the Experts" page and select one of these topics: "Financing a home," "Saving & Investing" or "Money." Read more Dr. Don columns for additional personal finance advice.