Sunday Times

Revenge of the mighty US dollar

Many stricken economies fear the imminent end of liquidity

- AMBROSE EVANS-PRITCHARD

SITTING on the desks of central bank governors and regulators across the world is a scholarly report that spells out the vertiginou­s scale of global debt in US dollars, and gently hints at the horrors in store as the US Federal Reserve turns off the liquidity spigot.

This dry paper is the talk of the hedge fund village in Mayfair, and the stuff of nightmares for those in Singapore or Hong Kong caught on the wrong side of the biggest currency margin call in financial history.

“Everybody is reading it,” said one former employee of the New York Federal Reserve Bank.

The report, “Global dollar credit: links to US monetary policy and leverage”, was first published by the Bank for Internatio­nal Settlement­s in January, but its biting relevance is growing by the day.

It shows how the Fed’s zero rates and quantitati­ve easing flooded the emerging world with dollar liquidity in the boom years, overwhelmi­ng all defences.

This abundance enticed Asian and Latin American companies to borrow like never before in dollars — at real rates near 1% — storing up a reckoning for the day when the US monetary cycle should turn, as it is now doing with a vengeance.

Contrary to popular belief, the world is more dollarised than ever before. Foreigners have borrowed $9-trillion (about R110-trillion) in US currency outside American jurisdicti­on, and therefore without the protection of a lender-of-last-resort able to issue unlimited dollars in extremis. This is up from $2trillion in 2000.

The emerging market share — mostly Asian — has doubled to $4.5-trillion since the Lehman crisis, including camouflage­d lending through banks registered in London, Zurich or the Cayman Islands.

The result is that the world credit system is acutely sensitive to any shift by the Fed. “Changes in the short-term policy rate are promptly reflected in the cost of $5-trillion in US dollar bank loans,” said the BIS.

Markets are already pricing in such a change. The Fed’s “dot plot” — the gauge of future thinking by Fed members — hints at three rate rises this year, starting in June.

The world is on a dollar standard, not a euro or a yen standard

The BIS paper’s ominous implicatio­ns are already visible as the dollar rises at a parabolic rate, smashing the Brazilian real, the Turkish lira, the South African rand and the Malaysian ringgit, and driving the euro to a 12-year low of $1.06.

The dollar index has soared 24% since July, and 40% since mid-2011. This is a bigger and steeper rise than the dollar rally in the mid-’90s — also caused by a US recovery at a time of European weakness, and by Fed tightening — which set off the East Asian crisis and Russia’s default in 1998.

Emerging market government­s learnt the bitter lesson of that shock. They no longer borrow in dollars. Companies have more than made up for them.

“The world is on a dollar standard, not a euro or a yen standard, and that is why it matters so much what the Fed does,” said Stephen Jen, a former IMF official now at SLJ Macro Part- ners. He said the latest spasms of stress in emerging markets were more serious than the “taper tantrum” in May 2013, when the Fed first talked of phasing out quantitati­ve easing.

“Capital flows into these countries have continued to accelerate over recent quarters. This is mostly fickle money. The result is that there is now even more dry wood in the pile to serve as fuel.”

Jen said Asian and Latin American companies were franticall­y trying to hedge their dollar debts on the derivative­s markets, which drove the dollar even higher and fed a vicious circle. “This is how avalanches start,” he said.

Companies are hanging on by their fingertips across the world. Brazilian airline Gol was sitting pretty four years ago, when the real was the strongest currency in the world. Threequart­ers of its debt is in dollars.

This has now turned into a ghastly currency mismatch as the real goes into free fall, losing half its value. Interest payments on Gol’s debts have doubled, relative to its income stream in Brazil.

The loans must be repaid or rolled over in a far less benign world, if possible at all.

You would not think it possible that an Asian sovereign wealth fund could run into trouble, but Malaysia’s 1MDM state fund came close to default earlier this year after borrowing too heavily to buy energy projects and speculate on land. Its bonds are now trading at junk level.

It became a piggy bank for the political elites and now faces a corruption probe, a recurring pattern in Brics as the liquidity tide recedes and exposes the underlying rot.

BIS data show that the dollar debts of Chinese companies have jumped fivefold to $1.1trillion since 2008, and are almost certainly higher if disguised sources are included.

Manoj Pradhan, of Morgan Stanley, said emerging markets weathered the dollar spike last year because the world’s deflation scare was holding down the cost of global funding. These costs are now rising.

The added twist is that central banks in the developing world have stopped buying foreign bonds, after boosting their reserves from $1-trillion to $11trillion since 2000.

The Institute of Internatio­nal Finance calculates that the oil slump has slashed petrodolla­r flows by $375-billion a year. Crude exporters will switch from being net buyers of $123billion of foreign bonds and assets in 2013 to net sellers of $90billion this year.

China has also changed sides, becoming a seller late last year as capital flight quickened. Liquidatio­n of reserves automatica­lly entails monetary tightening within these countries.

Nobody should count on a Fed reprieve this time. The world must take its punishment. — ©

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