The mighty US dollar…
It’s the epicentre of the global financial system…
The safe-haven asset for global markets and investors…
The greenback — the currency global markets rely on to remain resilient — may actually cause the next financial crisis.
‘Wait,’ I hear you say, ‘There’s no way US policymakers would let that happen. They bailed out Wall Street in 1997 and the financial market in 2008. Won’t they just do it again?’
After months of research, I’m convinced there’s no chance the US can bail out the world this time.
In March, I sat down with Daily Reckoning Australia strategist Jim Rickards for an exclusive interview.
Over the past couple of weeks, I’ve noticed the mainstream press is only just beginning to explore this same issue we talked about all those months ago.
Emerging markets (EMs) are loaded with debt…more than they can handle. They’re drowning in US dollar-denominated loans.
So far I’ve uncovered about US$10 trillion worth of debt. Granted, that’s only about 5% of the world’s total US$200 trillion non-bank, non-government debt.
But if my research is correct, there’s a good chance this debt may never be repaid.
If that’s the case, the entire house of cards will blow over, leading to an aggressive new financial crisis.
George Soros, the famous hedge fund manager who broke the Bank of England in 1992, commented on the possibility of it this week.
He told attendees at a Paris conference on Monday that a rising US dollar would encourage capital flight from emerging markets, leading to a major financial crisis.
As you know, investor capital flows to markets where it can see higher returns with limited risk.
If the Federal Reserve Bank is raising rates, capital parked in the US is going to attract higher returns. And that’s before accounting for the perceived safety of the US dollar and the US economy, which boosts investor confidence.
Contrast that to India, for example. India has a cash rate of 6%, yet foreign investors don’t consider funds stored in India as safe as they would be in the US. Even though the Fed funds rate is 1.75%, investors trade in the higher return for the assurance that their funds are safe.
Of course, that’s the theory.
But markets have a way of surprising people…
Government debt isn’t the problem
Over the past month, funds have fled emerging markets.
That’s caused the value of the US dollar to rise, with EM currencies falling.
Some analysts are downplaying this as nothing more than speculators looking to make a quick buck in currency markets.
But they haven’t dug as deep into this as Jim and I have.
It’s all eerily similar to the Asian Financial Crisis in 1997…money rushing from one place to another…leaving a trail of debts that won’t be repaid.
Except this time, the market is bigger, and global markets are more connected than ever before.
As a result, what you’re seeing isn’t just a handful of traders fishing for the biggest profit.
Emerging market currencies are weakening, and the extent of the loans is being revealed.
Take Brazil for example. As you can see in the chart above, Brazil is now sitting on US$300 billion in US dollar-denominated loans. Same goes for Russia.
China is in a league of its own, however, with more than $1 trillion of US dollar-denominated loans outstanding.
This is largely non-bank, non-government debt. It belongs to corporations — companies looking to fund their expanding business activities.
To fund activities, these companies take out loans with international banks. Sometimes, they’ll offer up debt securities — such as corporate bonds — as a source of funding.
Between China, Russia and Brazil, they’re sitting on about US$1.7 trillion in combined US dollar-denominated debt. Again, this excludes government and bank debt. Meaning it’s still not even close to the full amount these nations owe.
Of course, it’s preferable to have US dollar-denominated debt because of the perceived safety of the greenback. Few people don’t want rubles, renminbi or reals. Especially not when it comes to risky, emerging markets.
So these corporations offer up loans or bonds in US dollars to make them more attractive to the international market.
None of this debt is a problem when markets are stable. It just gets rolled over.
But the market is in a precarious position today.
The Federal Reserve Bank is raising rates. In fact, US rates could rise to 2.5% in two years.
All these US dollar-denominated loans need to be paid back in US dollars.
But as more investors rush out of emerging market currencies — like the renminbi, real and ruble — it weakens the local currencies.
As a currency weakens, more of it is needed to pay off US dollar-denominated debt.
Suddenly, emerging markets are scrambling to find more money to pay back debt…but the cost of that debt is going up. Meaning even more cash must be found to pay back the debt.
All told, global markets are sleepwalking into a crisis the likes of which we have never seen before.
This time, the US dollar isn’t going to be the white knight to save the world economy.
This article was originally published by The Daily Reckoning Australia