James Saft at Reuters has a fantastic piece on the longer-term impact of the U.S. debt ceiling crisis. Saft, after a quick analysis of the current situation, takes a step back to look at how the loss the U.S. Treasury as a key risk benchmark for the world financial system could impact the global financial industry.
Remarking on the usefulness of a universal risk benchmark, Saft notes:
Investors have believed, mistakenly it turns out, that they can measure risk by comparing all credits to the U.S. Treasury benchmark. This has been an incredibly useful convention, giving financial markets a foundation upon which to build riskier investments, a means to gauge risk and a harbor to flee to when seeking safety.
The increased cost of debt service for the U.S. government may pale in significance to the loss of a Pole Star around which finance decisions can be based. As Saft points out: “A huge preponderance of all of the decisions and investments made in financial markets rely, directly or indirectly, on the concept of a risk-free rate.”
The 1944 Bretton Woods agreement that solidified the centrality of the USD in the world financial system has been under pressure for some time. During the middle of the last decade there was a great deal of talk of a new, informal system, dubbed “Bretton Woods II”, in which the mercantilist purchases of U.S. Treasuries by China, Japan and South Korea provided cheap financing for U.S. deficits and in turn allowed U.S. consumers to continue importing Asian goods.
Saft’s suggestion that the loss of the Treasury as a benchmark risk measure will pressure the weakest credits the most is very much in line with my own view. The credit markets recovered their exuberance remarkably quickly after the 2008-9 recession, but continued weakness in the U.S. economy suggests that it would take little to force a retrenchment among lenders.
About the author:
David Johnson is a partner with ACM Partners, a boutique financial advisory firm providing due diligence, performance improvement, restructuring and turnaround services to companies and municipalities. He can be reached at 312-505-7238 or at [email protected].
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