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Is U.S. risking ‘faith’ in greenback as reserve currency? In time, yes

These are stories Report on Business is following Wednesday, Oct. 16, 2013.

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U.S. risks reputation
There's certainly an issue of credibility where the United States and its currency are concerned, but it's not as simple as Fitch Ratings would have you believe.

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Here's what the ratings agency said late yesterday as it warned U.S. politicians about the threat of their fiscal impasse:

"The prolonged negotiations over raising the debt ceiling (following the episode in August 2011) risks undermining confidence in the role of the U.S. dollar as the preeminent global reserve currency, by casting doubt over the full faith and credit of the U.S. This 'faith' is a key reason why the U.S. triple-A rating can tolerate a substantially higher level of public debt than other triple-A sovereigns."

Observers certainly agree there's a credibility concern here, but that the status of the greenback isn't about to change any time soon.

"The issue of credibility is a real one; however, the U.S. still has the largest and deepest capital markets in the world which for now still buys them the title of global reserve currency," said Camilla Sutton of Bank of Nova Scotia.

"There really are not a lot of alternatives, potentially Japan, but that too has its own problems," the bank's chief currency strategist added.

"European markets also have hurdles. For the U.S., politics could see its position as global reserve currency deteriorate fast than it otherwise would – but this is still likely to be measured in years, not months."

Sébastien Galy of Société Générale's foreign exchange group also sees things differently.

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"The U.S. trades as a triple-A because the world is financing a higher degree of consumption in the U.S.," he said.

"The alternative would be to let the USD fall vs. the rest of the world, largely wiping out the manufacturing and export industries in emerging markets," he added, referring to the currency by its symbol.

"As the speed with which this imbalance can adjust is slow, the U.S. finds it easy to finance itself externally and especially so in an environment of still significant risk aversion as the world operates below its output gap."

The short-term impact is on Treasury yields, but, as Ms. Sutton noted, that's not to suggest there couldn't be a shift over time.

"Certain officials in China, the U.S.'s largest creditor, have accepted that for now there is little alternative to holding U.S. debt due to the sheer size of their reserves," said market analyst Craig Erlam of Alpari.

"However, they have said in the future, eurobonds could be an alternative if and when they are introduced. The damage being done in Congress right now may not be instantly felt, but may be irreversible further down the line."

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Where things stand
I can't get the theme song from Jaws out of my head today as the clock ticks down on the U.S. fiscal crisis and warnings come fast and furious on just what's at stake.

To recap, there's still no deal that would end the U.S. fiscal crisis as tomorrow's deadline looms, raising the spectre, while extreme, of a U.S. default.

Based on the markets this morning, stock investors still hold out hope for a resolution before tomorrow, after which the U.S. Treasury Department says the government will be tapped out.

"Maybe now is the time for markets to start turning the screw in order to impress upon complacent politicians that playing Russian roulette with the U.S. economy is not the low risk strategy that many on Capitol Hill maybe think that it is," said senior analyst Michael Hewson of CMC Markets in London.

There's no market panic yet, though investors are clearly nervous.

"This bravado is unlikely to last much past the early afternoon, however; providing there are no further developments by then, an aggressive sell in late afternoon trading could well take place," warned market analyst Alastair McCaig of IG in London.

Deadline approaches
Some random bits from the financial markets today:

1. Warren Buffett, the famed investor, likened the Washington impasse over the debt ceiling to a "political weapon of mass destruction," telling CNBC that "I know we've used it in the past. But we used the atomic bomb back in 1945."

2. While stock markets aren't in panic mode, other markets are trembling.

Mr. Hewson: "Even if equity markets aren't concerned about the ability to pass some form of deal U.S. short term Treasury markets are, as yields continue to spike higher."

Market analyst Craig Erlam of Alpari: "As it stands though, investors remain convinced that a deal will be done before tomorrow's deadline … Ultra short-term Treasury yields suggest otherwise, having risen again yesterday to 0.3397 per cent, up from 0.0203 per cent less than two weeks ago."

3. Mr. McCaig on America's credit rating: "The silence coming out of America is deafening. The lack of progress has already encouraged one of the debt rating agencies, Fitch, to put U.S. debt on a negative watch, and surely it can't be long before others follow suit – regardless of any agreements reached today."

4. Mr. Hewson on what happens next: "For now it would appear that certain politicians don't really get it and while we may not get a default on 17th you can be sure that if we go beyond the deadline, which looks increasingly likely, expect investors to start voting with their feet if we don't get a deal by the weekend. The next deadline would then be 23rd October when a $12-billion social security payment is due."

Minding the gap
The Canadian government wants to narrow the gap between consumer prices in Canada and the United States, but that may be easier said than done.

As The Globe and Mail's Steven Chase reports, the government through its Throne Speech this evening will promise to try to eliminate the Canada-U.S. price gap, which, according to the latest study, is running at about 10 per cent.

But while policy makers could work to cut tariffs, particularly on products no longer made in Canada, there's no quick fix, the authority on the subject warned today.

"The reality is that there is no easy or magic solution, where Ottawa could just pull a lever and – poof – the gap would vaporize," said chief economist Douglas Porter of BMO Nesbitt Burns, who has tracked the price gap for years.

"The only thing that could do that would be an abrupt drop in the value of the Canadian dollar," he added, noting the findings of a February Senate report on the issue.

"I still believe that this was the quiet conclusion from the Senate report – that the C$ was simply overvalued at close to parity, and the most straightforward way we would see the gap disappear would be if the loonie weakened notably. That's not something Ottawa can (or should) easily control."

Société Générale's Mr. Galy of  said there could, of course, be an impact, but that depends on how far the government goes.

"The outcome would be deflationary in Canada if the decision is sizable enough, an open question, keeping the [Bank of Canada] on hold for longer and boosting real disposable income for Canadians," he said in a research note.

"The real problem in Canada is lack of productivity relative to the U.S., but none of the decisions at the speech seem to address this. "

According to Mr. Porter's most recent findings, the gap in prices on his basket of goods has narrowed to 10 per cent from 14 per cent in May, 2012.

The difference ranges from 34 per cent on baby items and 19 per cent on running shoes to just 3 per cent on electronics and 1 per cent on sporting goods.

(For Mr. Porter's research, see the accompanying infographic or click here.)

Sawaris slams Canada
Egyptian telecom investor Naguib Sawiris vows to never again consider investing in Canada after the government's decision to block a $520-million bid for Manitoba Telecom Services Inc.'s Allstream division, according to a published report.

"I am finished with Canada, I tell you," Mr. Sawiris is quoted in a lengthy article in Ahram Online, the English-language website of Egyptian news organization Al-Ahram.

"I regret that we wanted to invest in Canada," Mr. Sawiris is quoted as saying, The Globe and Mail's Bertrand Marotte reports.

The bid by Accelero Capital Inc., led by Mr. Sawiris, was rejected by the government on national security grounds.

SNC cuts outlook
SNC-Lavalin Group Inc. is slashing its annual profit forecast to well below its previous projection, The Globe and Mail's Bertrand Marotte reports.

The Montreal-based company engineering and construction giant said late yesterday now expects 2013 profit of between $10-million and $50-million. That's in stark contrast to previous guidance of between $220-million and $235-million.

"Certain legacy fixed price contracts entered into by the company between 2010 and 2012 and the ongoing softness in the mining sector unfortunately continue to stress our performance in 2013," SNC chief executive officer Robert Card said in a statement.

What's up with the 5C?
Is there an issue with the new iPhone 5C?

Various reports today suggest Apple Inc. is planning to cut orders of the new model in the current quarter.

Reuters, for example, reports that Apple has told manufacturers it will do just that, suggesting that the new lower-end, plastic phone was priced too high to begin with.

Indeed, CanaccordGenuity analyst Michael Walkley said today that his checks at stores indicate the higher-end 5S are outpacing sales of the 5C by about 2.5"1.

This "significantly higher sell-through" should help Apple results, Mr. Walkley said as he boosted his price target on Apple shares to $580 (U.S.) from $560.

"With our expectations for a full redesign for iPad 5 and increased near-term iPad 5 versus iPad Mini supplier build rates, we believe December quarter iPad sales mix will shift toward the iPad 5 versus iPad Mini," he added, referring to an Oct. 22 announcement by the tech giant.

Some analysts warned against reading too much into the reports related to the 5C.

"There are too many moving parts in the supply chain to draw any conclusions," Benedict Evans of Enders Analysis told Reuters.

Factory sales slip
Canadian manufacturers suffered a setback in August as sales dipped 0.2 per cent, ending three months in a row of increases.

Sales slipped in 11 of 21 sectors measured by Statistics Canada, the agency said today, which accounted for about 40 per cent of all shipments.

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About the Author
Report on Business News Editor

Michael Babad is a Report on Business editor and co-author of three business books. He has been with Report on Business for several years, and has also been a reporter and editor at The Toronto Star, The Financial Post and United Press International. His articles have appeared in major newspapers around the world. More


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