The Government Shutdown May Have Done Serious Harm to the U.S. Dollar

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A lot has been said and written about Washington's recent political shenanigans. Over the past couple of weeks, economists and analysts around the world became frantic and started pondering the worst-case scenarios.

Motley Fool columnist Morgan Housel, on the other hand, stayed calm and gave investors some sage advice. He suggested that the most important thing they should remember during a government shutdown is to think ahead to the future and not fuss over a short-term political impasse.

Even so, what's the big picture?

Not a big deal?

It's been nearly two decades since the last time budget fights in Congress led to furloughs for federal employees, and it seems as if nothing much has changed. Housel dug through some newspapers to see what people were saying about the shutdown back in late 1995 and early 1996. It was the same old story - Democrats and Republicans played the same blame game back then.

"We've been there before," Morgan noted, and it's highly likely that history will repeat itself sooner or later.

All in all, "If you're a government employee, a shutdown has a real impact on you and your family. But if you're an investor watching from the outside, this stuff should have virtually no impact on how you invest or think about the economy," he concluded.

Morgan is right. The shutdowns or "funding shortfalls" have never sent the stock market into a panic. In some cases the market actually moved up.

During the 16-day period Uncle Sam was closed for business, the Dow Jones Industrial Average went up by 1.2%. The S&P 500 gained around 1.6%.

At the end of the day, if you are an investor, a government shutdown is not a big deal. But, what happens if you are an American businessman selling goods abroad or a foreign freelancer working for an American company? Then, a government shutdown is kind of a big deal. Every time American politicians engage in brinkmanship over the budget and the debt limit causing the U.S. dollar to plummet, you lose money.

As soon as the second week of the shutdown kicked in, the dollar foundered upon an eight-month low versus the euro. Amid heated budget and debt negotiations, it traded poorly against the euro, the Japanese yen and the Australian dollar. To top it all, political stalemates, which based on analysts' calculations could result in a $24 billion hit to the U.S. economy, drove the Fed to put tapering of bond purchases on hold.

No wonder why, going forward, analysts and traders don't pin their hopes on the greenback bouncing back. According to CNBC's latest poll of currency sentiment, almost 90% of the respondents expect the U.S. dollar to remain trapped in a downtrend.

Given the fact that the global economic and financial system relies largely on the American dollar as a medium of exchange, unit of account, and reserve currency, isn't it time Washington got its act together and stopped its political shenanigans?

So far, the dollar's international status has come in handy for the U.S. after all. For the 20-year period between 1990 and 2010, the World Bank estimated that U.S. seigniorage income derived from the greenback's status has averaged $15 billion per year. When foreign demand for dollar assets was factored into the equation, U.S.-based borrowers enjoyed an extra annual cost of capital advantage of $33 billion a year.

In the aftermath of the shutdown, however, confidence in the U.S. political system is shaken. And with another round of debt ceiling negotiations coming up early next year, overseas investors would think twice before financing the world's biggest debtor.

A powerful economy needs a strong currency in the same way an international currency requires, among other things, an efficient government to shore it up.

Final thoughts

Morgan Housel made a good point in saying that investors should keep their eye on the long term. But it's what's going to happen over the long term that worries me most.

A lot has changed since 1995. Back then, China was not even a member of the World Trade Organization. Today, despite its ups and downs, China is indeed a global superpower. More importantly, it has been slowly but surely promoting the internationalization of yuan.

While at the moment, toppling the American dollar from its throne is nothing but wishful thinking, no one can deny that this scenario is still on the table.

Washington needs to keep that in mind and not take foreign investors' patience for granted. 

The deal with the debt

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