THE Australian dollar surged yesterday after investors fled the greenback as global financial markets remained on edge about the possibility of a US debt default. All eyes remained on the US yesterday as President Barack Obama warned of the possibility of incalculable damage to the US economy even if the debt problem was resolved before the August 2 deadline but the US's AAA credit rating, which it has held for nearly a century, was downgraded. He said a debt default would be "'reckless and irresponsible" and that the Republicans' deficit reduction plan proposed by House Speaker John Boehner was "dangerous". "For the first time in history, our country's AAA credit rating would be downgraded, leaving investors around the world to wonder whether the US was still a good bet," he said. His comments put further pressure on the US dollar, boosting the local unit to a 12-week high. The Australian dollar was trading at US109.31c at the local 5pm close, its highest since May 4, and up from US108.13c. "The market is very much focused on what's happening in European and US debt markets, and when you combine that with the fact that we are heading into Australian reporting season, you have a recipe for a volatile market," said a senior trader at a major brokerage. The sharemarket recovered from Monday's 72 point selloff, with the S&P-ASX 200 closing up 42.9 points at 4573.3, but traders remain nervous. Gold fell $US3.15 to $US1611 an ounce after strong gains this week, as the wrangling over a plan to lift the debt ceiling above $US14.3 trillion continued. Bell Potter managing director Charlie Aitken said markets were fully expecting a resolution of the US impasse, if only because the alternative was too dire to contemplate. "In my view, this remains classic political theatre in Washington, with no US politician truly stupid enough to see the US default," he said. "Put it this way: if we were truly on the cusp of a US debt default, gold would be $US3000 and ounce, the US dollar would be 25 per cent lower and the Dow 4000 points lower." John Kyriacopoulos, chief currency strategist at National Australia Bank, said the Australian dollar had taken on the cloak of a "safe haven asset". He said that the share of global central bank reserves denominated in currencies such as the Aussie grew to 4.7 per cent in the first quarter of 2011 from 4.4 per cent in the December quarter and 3.6 per cent compared with a year earlier. The climb over the year represented about $93 billion and Australia's share would have been about 15 per cent, or $US14bn, he said. Tony Morriss, senior interest rate strategist at ANZ, said the stronger Australian dollar, flight-to-quality and heightened economic uncertainty following the US developments should also support Australian bonds in higher ranges. "There is scope for the (Australia to US 10-year bond spread) to head towards 2010 lows near 170 basis points," Mr Morriss said. The Dow Jones Industrial Average fell 88 points on Monday night, as investors started to assess the impact of a default. Major European markets opened lower last night, with the sovereign debt burdens in the eurozone still weighing heavily on sentiment. Spain was last night forced to offer sharply higher returns to sell E2.885bn ($4.17bn) in short-term bonds as a result. The Spanish Treasury had to offer a rate of 1.899 per cent to borrow money for three months, up from 1.568 per cent.

Source