IMF: Dollar May Weaken if Debt Ceiling Not Raised

The head of the International Monetary Fund (IMF) said the U.S. dollar may decline in value as financial markets lose confidence that the U.S. Government will pay its bills, if Congressional lawmakers fail to reach an agreement on the debt ceiling.

IMF Managing Director Christine Lagarde said if Democrats and Republicans in Washington cannot reach an agreement to raise the debt ceiling by Aug. 2 "it would probably entail a decline of the dollar relative to other currencies," Dow Jones reported Friday, citing PBS.

The inability to raise the debt ceiling would also create "doubts in the mind of those people who reserve currencies as to whether the dollar is effectively the ultimate and prime currency of reserve," Lagarde added. Lagarde also asked for "political courage."

So far, the currency market, also known as the foreign exchange, or forex, has been relatively calm. The dollar, which was at $1.4349 down a half-cent versus the euro Friday afternoon, has traded in a rough band versus the European currency. The dollar has fallen versus the pound, yen, and fallen to a record-low versus the Swiss franc at 0.7853 francs during the debt saga, but there have been no "brutal" moves in the currency market, to cite a phrase European Central Bank President Jean-Claude Trichet popularized.

Monetary/Economic Analysis: Without question, if the U.S. debt ceiling is not increased, the dollar will lose appeal, particularly if investors quickly conclude that dollar-denominated investments, such as U.S. corporations, will see their revenue and earnings hurt by ripples from a U.S Government default.

The counter-argument to the above is that the dollar is the world's reserve currency -- historically a safe-haven during international crises. But a U.S. Government default would be a crisis affecting the dollar like no other -- something that could cause institutional investors to reevaluate the dollar's reserve currency status, and undermine the dollar bulls' stance.