October 10, 2014

The Subtle Crack

The dollar. The intangible monetary construct concocted in its paper form in 1861 to finance the civil war is arguably the United States' most precious asset. Its solidity is underpinned by an enviable rule of law. It gives good ol' U.S. of A the blessing of perennially low interest rates (which elevates the standard of living of Americans to the tune of $100bn annually), and the ability to throw in the trash can any resemblance of fiscal restrain. Why be frugal when normal market rules don't apply to you? After all, there is no such thing as a U.S. Treasury bond market "vigilante." Not in the same way they exist for any other --more normal-- sovereign bond markets, anyway.

We live under a de facto Dollar Standard. Nations hoard greenbacks to bulk up reserves (save some very wacky exceptions) to have dry powder to prop up (or push down, as recently seen) their currencies when they're under attack, or to buy imported goods. It is a very exorbitant privilege for the U.S. indeed.

The anointment of the Dollar as the standard has granted the U.S. much of its economic stability. You'd expect that the political class of the U.S. would realize how incredibly beneficial this is for their country, and do their best to keep the status quo... and you would be wrong. Despite their best efforts to self-sabotage the Dollar's status as the main reserve currency in the world, every time there's a crisis concerning the very solidity of the Dollar, a run to the greenback ensues.

And as if this privilege was not exorbitant enough, the Dollar Standard gives the U.S. yet another (much less trumpeted) power: the capacity to rule over other sovereign nations on matters of national interest. Once a country signs the Faustian indenture that allows it access to Dollar debt markets, it surreptitiously surrenders its self-determination as a State over to the U.S. legal system. Don't believe me? Ask Argentina.

Pegging your financial fate to a currency other than the one produced by your own printing press should naturally place you at a disadvantage right out of the gate. But what does not get talked about is the fact that by accepting to participate in the Dollar standard, countries (or any foreign issuer) are tacitly subjecting themselves to the fundamental flaws of the institutions that underpin the greenback.

I am talking about regulatory and legal capture. I assure you few international issuers looking to get financing in Dollars stopped for a moment to question the effectiveness (or fairness) of the rule of law that would govern the contractual obligations they were about to be bound to. The Dollar's prestige is (or was, at least) that good. But after Judge Griesa's asinine ruling (that hedge funds who bought defaulted, non restructured debt for cents on the dollar are entitled to par repayment because the issuer is paying those other who did restructure), many definitely will. The U.S. legal system has de facto been hijacked by the same institutionalized shenanigans that afflict the political system of that country, and now, thanks to precedence, this whole charade will corrode future default procedures.

The global markets can't function when the legal institutions that underpin what should be the most solid currency in the world are hijacked by narrow economic interests. As mentioned in an earlier post, the consequences of the loss of confidence in the world's reserve currency cannot be overstated. It seems that yet another structural crack has appeared in the global financial system, and although subtle, this one may be even more important than the one that occupies headlines every six months.