Meanwhile, while the discussion over foreign US funding risks remains hot, US credit default spreads have been stable. Sure, US foreign held assets are substantial, but of the USD 8trn of foreign liabilities, more than half are held by foreign central banks. Official accounts are unlikely to move these assets out of the USD unless there is a credible alternative as a reserve currency. The EUR has failed the test for now with its peripheral debt and competitiveness problems and the RMB is not yet fully convertible. The lack of alternatives will keep the USD in place as a reserve currency, buying the US authorities time to get their fiscal house in order. If there was be an alternative reserve currency on hand now, the USD would be much more vulnerable to a funding crisis. In this sense, bad news from EMU and China going slow in making the RMB fully convertible is good news for the US. Chart 2 shows that the US CDS spread has moved less compared to the GDPweighted EMU CDS spread, despite the eurozone running at an aggregate level lower private and public debt levels than the US. The muted reaction of the US CDS to ballooning US deficits is related to the USD’s still-unchallenged status as a reserve currency.Click on charts to enlarge, courtesy of BNP Paribas.
So much for the free markets...
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