Why American fear will linger

Although a crisis was averted in the nick of time, the shutdown hurt America's economic clout. It will encourage the world's gradual shift from the greenback.

When we look back upon this time in history, we will realise that the American events of October 2013 changed the world forever.

For the first time, David Blitzer, chairman and managing director of the Index Committee of S&P Dow Jones Indices, reveals in an interview to be published later today just how close the world came to a repeat of the global financial collapse that was triggered by the collapse of Lehman Brothers in September 2008. 

The Lehman collapse triggered the freezing of the repurchase agreements (or ‘repo’ market). In 2008, repos were backed by mortgage-backed securities.

As Blitzer explained to the KGB, five years later the multi-trillion dollar repo market is now backed by US government bonds. If the US bonds were not honoured, then the effect on the global derivatives market (which banks depend on) would have been catastrophic and almost certainly would have caused another global financial crisis (America’s too big to fail moment, October 14).

The stock market never believed that would happen, and believed that at the last moment the Republicans would back off. It turned out the market was right and the electoral consequences for the Republicans – a near wipe-out of the party – caused them to pull back. Nevertheless, the world was less than 24 hours away from a crisis when the necessary action was taken by the US Congress.

In theory, it could happen again next January. While that is highly unlikely – the Republicans surely have learned their lesson – no one can be absolutely sure.

The Australian government now realises that the capital of our central bank was not prepared for such an event, so it has injected $8.8 billion.

China must have been horrified. Its would have reached the same conclusion as Blitzer: that the world was on the brink of another financial crisis. Not only were the Americans effectively threatening to bring on a crisis that would badly damage China, but they were threatening to lower the value of US government securities in which China has invested vast sums (to enable Americans to buy Chinese goods).

Clearly the Chinese now need to diversify their international investments. Even before the American crisis, next month's meeting of the Chinese Communist Party was planned as a forum for China‘s new leadership to detail its plans for financial reform to enable Chinese to invest abroad much more easily (China’s ‘wall of money’, October 14).

In light of the instability in the US, that strategy takes on a new urgency. Tony Abbott has agreed to negotiate a China free-trade agreement within 12 months. The main obstacle is the ability of the Chinese to invest up to $1 billion in Australia without Foreign Investment Review Board approval. They will now press Abbott very hard on this issue and the fact that he gave a deadline will gives them an opportunity (Abbott's in danger of a Chinese checkmate, October 11).

Longer term, China aims to have more and more of its trade designated in renminbi rather than US dollars and gradually lower the dominance of the US dollar as the world trading currency. That pressure will also apply to Australian mineral exports.

Once again, the events of October 2013 will cause those efforts to be intensified.

Over the long haul, the world will become less dependent on the US dollar. America will, in time, find it harder to borrow in its own currency. Of course, the Americans would argue that the sharp fall in the US deficit and the prospect of further falls as it becomes less and less dependent on Middle-Eastern oil will mean the US will stay strong.