Fitch downgrade of U.S. Debt hastens Dollar’s Displacement as Default Global Currency

By K Raveendran

 When empires fall, they don’t exactly come crashing down. It is a process that takes time to complete. So when rating agency Fitch decided to lower the credit rating of the United States triple A to AA+, the market was not expecting the heavens to fall. But it is a clear disapproval of the economic policies of America.

The Fitch downgrade, which puts a question mark over the credibility of American debt, is the first in over 10 years after S&P lowered the US rating in 2011, a downgrade that the rating agency has refused to change since then.

Fitch had issued a warning in May this year that there might be a credit rating cut if the United States did not address the debt ceiling issue. This problem was resolved by raising the debt limit until the projected 2025 year, but it doesn’t change the issues that the rating agency had flagged. It pointed to deteriorating management standards in the US over the last 20 years, potential fiscal issues in the next three years, and a massive increase in interest costs in recent years. The interest cost has ballooned from $500 billion in 2020 to almost $1 trillion.

The market has taken the news in its stride in the sense the reaction has been rather muted, although dollar continues to smart under some big hits. The current U.S. debt market is almost five times larger than the total market of all other government issuers with an AAA rating and nearly four times larger considering countries with a prevailing AAA. So there is a dearth of alternatives.

The big question, however, is how long will the financial hegemony of the U.S. last, especially since there is growing competition from Asia. Clearly there are risks that could accelerate the passing of the leadership baton. Experts have warned that the surprise US credit rating downgrade will not doubt trigger short-term volatility for the dollar, but more importantly, it will speed-up the long-term decline of the US and global reserve currency.

Apparently, the rivals of America, led by China, are forming a new major economic bloc. The outcome of a three-day summit between Russia’s Vladimir Putin and China’s Xi Jinping recently has big implications for the US and its currency. It emerged from the meeting that Putin declared Russia’s intention to switch to the Chinese yuan for oil settlements.

In this respect, two recent deals in oil trade are ominous for the dollar. Under one of these, Saudi Arabia’s Aramco will supply two Chinese companies with a combined 690,000 barrels a day of crude oil, bolstering its rank as China’s top provider of the commodity. Saudi Arabia is reportedly in talks with Beijing to settle with the yuan instead of the dollar.

If Saudi Arabia does move to the yuan, that would lead to an enormous shift in the global economic system. Oil has played a significant role in ensuring the dominance of US dollar as it is one of the most widely traded commodities and is prices in the US currency. Every time an oil trade takes place in dollar, it adds to the clout of the US currency because the buyer has to acquire the value in dollar.

But if oil trading were to shift away from the US dollar, it would dramatically reduce the demand for US dollars, which would lead to a decrease in the value of the US currency. And this could have a number of ripple effects throughout the global economy, including hugely increased inflation in the United States and potentially destabilising effects on financial markets.

China has never made a secret of its desire to make the yuan a global force and probably the default global currency, dislodging dollar from that position. The Chinese government launched the Cross-Border Interbank Payments System in 2015 to facilitate cross-border payments in yuan. Three years later, in 2018, it launched the world’s first yuan-denominated crude oil futures contracts to allow exporters to sell oil in yuan.

The Ukraine war and the crisis that followed the slapping of embargo by western nations has given a major push for the yuan, with even third countries to preferring to settle their trade using the Chinese currency, which has the Chinese laughing away to glory. (IPA Service)

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