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Washington is slowly killing the dollar

October 10, 2013: 12:51 PM ET

The dollar is looking less almighty. It won't remain the world's reserve currency if Washington can't get its act together.

The opinions expressed in this commentary are solely those of Paul R. La Monica. Other than Time Warner, the parent of CNNMoney, Abbott Laboratories and AbbVie, La Monica does not own positions in any individual stocks.

The United States dollar may still be like Leonardo DiCaprio in "Titanic." It's the king of the world! But if politicians keep acting like toddlers, the greenback may eventually suffer the same fate as that not-so-unsinkable ship.

Now don't get me wrong. The dollar remains the world's reserve currency. It's what most people around the world use as their benchmark for trading, investing and other financial transactions. And there is no viable alternative at this time.

However, confidence in the dollar may gradually erode as Congress does its best impersonation of Italy. That's not a compliment. My ancestral homeland is famous for great food, wine and art. But a normal, functioning government? Not so much.

It's getting harder for investors to write off the problems in Washington as isolated events. The current debt ceiling drama is the third time since the summer of 2011 that lawmakers and President Obama have brought the country to the brink of a fiscal disaster.

Andrew Milligan, head of global strategy for Standard Life Investments in Edinburgh, Scotland, used a soccer (football for those of you outside the 50 States ) analogy to describe his concerns about the dollar. He joked that the United States is in danger of being demoted to the second division of governments.

"The U.S. is not as dysfunctional as Italy. But it's moving south fast," he said.

The value of the euro has moved higher against the dollar for the past decade (albeit in bumpy fashion) ... despite the enormous debt crisis that's gripped the European continent over the past few years.

What are the implications of this? Milligan stressed that he does not think the U.S. will actually default on its debt. And it does look like there was some "progress" in Washington Thursday ... if you consider kicking the can down the road for six weeks progress.

CNN: House GOP leaders to propose short-term increase in debt ceiling

But that almost doesn't matter anymore. Milligan feels that many foreign investors are starting to grow tired of the partisan games in Washington.

He does not think the dollar is going to lose its reserve status overnight. It's a process that could take many years. But he believes the dollar won't be the world's preeminent currency forever. And the decline has already begun.

"It's only marginal for now. But over time, the political problems will undermine the willingness of international investors to buy U.S. dollars and dollar-denominated assets. What's happening in Washington is happening too frequently," he said.

Other countries are already voicing their displeasure with the kookiness on Capitol Hill.

Related: Europe and China agree to currency deal

Officials from China and Japan, which collectively hold more than $2.4 trillion of U.S. debt, have been urging the United States to get a debt deal done quickly.

And on Thursday, the operator of the Hong Kong futures market announced it was applying a discount to the value of short-term Treasuries held as collateral.

"Most U.S. investors have been complacent. But foreign investors are more concerned. They see this as a longer-term problem and don't think it's the right way to be running a government," said Scott Brown, chief economist at Raymond James.

But here's the rub. The dollar can probably remain the top global currency for the time being because there is no legitimate option to replace it yet.

Brown said that the euro and British pound are not going to zoom ahead of the dollar. And China's yuan is unlikely to be a suitable substitute for the dollar for decades.

And while I sympathize with all who would like a return to the gold standard -- or its 21st century equivalent of Bitcoin -- I just don't see that happening on a grand scale. (But with politicians constantly misbehaving, there is a certain appeal to alternative currencies that wouldn't be subject to the whims of elected officials.)

Milligan agreed that there's nothing that could bump the dollar from its pedestal immediately. But he envisions a scenario in the not-so-distant future where there is no longer only one undisputed reserve currency to rule them all. (Thanks, Gollum!)

Related: The yuan is now among the world's most traded currencies

The dollar could be joined by the euro and yuan as reserves for Europe and Asia, respectively. Instead of a global reserve, there would be super-regional reserves. The pound and Japanese yen would be in a second tier just below these three.

"It's going to be a multi-currency world. The dollar still has the advantage of liquidity. But it will be less dominant," Milligan said. And it goes without saying that if the dollar becomes less important, so does the economic prowess of the United States on the global stage.

Still, there is a chance that the dollar could avoid this fate. But it's up to the American people.

Related: Long-term bond investors refuse to panic

There are midterm Congressional elections next year. That could dramatically alter the landscape in the House. And a new president will enter the Oval Office in January 2017.  Bob Baur, chief global economist at Principal Global Investors, said he's not worried about the dollar for those reasons.

"A longer-term solution for the debt ceiling and budget is needed. Maybe the next elections will help sort some of it out," Baur said.

A good point. And I'm certainly not arguing against the benefits of democracy in action. But I wouldn't hold out high hopes that the next crop of "leaders" will be any better than the ones we've already voted into power.

Jonathan Lewis, chief Investment officer with Samson Capital Advisors, agrees. He said that barring a major change in Washington, the gradual decline of the dollar could be a "national tragedy." He said the trend is reversible, but the arrows are all pointing in the wrong direction.

"The government is not as effective as it used to be. That's indisputable," Lewis said. "If you're a foreign central bank or sovereign wealth fund and you want to protect your portfolio, you may be less likely to buy the dollar."

Reader Comment of the Week! My legion of Twitter followers (#sarcasm) know that I give out a daily award for the dumbest stock move of the day. One follower joked that a certain wrestler-turned-thespian should work on Wall Street. He could tell people to ignore those trivial things like earnings and valuation.

Ha! I think I can actually smell what you are cooking. But I hope Dwayne Johnson would not be allowed to comment on the stock performance of World Wrestling Entertainment (WWE) due to conflict of interest.

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Paul Lamonica
Paul R. La Monica
Assistant Managing Editor, CNNMoney

Paul R. La Monica is an assistant managing editor at CNNMoney. He is the author of the site's daily column, The Buzz, and also tweets throughout the day about the markets and economy @LaMonicaBuzz. La Monica also oversees the site's economic, markets and technology coverage.

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