Greenspan warning echoes 20 years on

LONDON: “It is just not credible that the United States can remain an oasis of prosperity unaffected by a world that is experiencing greatly increased stress,” former US Federal Reserve chief Alan Greenspan opined almost exactly 20 years ago.

With the dollar’s surge and Turkey’s crisis threatening a far deeper implosion across emerging markets, his words are just as relevant today: how long can the Fed continue going it alone in raising interest rates?

If the 1998 parallels hold up — and they are plentiful and striking — probably not long at all. Just days after Mr Greenspan’s speech on Sept 4, 1998, the Fed was cutting rates and the dollar was falling, albeit only for a couple of months.

The source of the increased stress that Mr Greenspan referred to then is pretty much the same as the root of emerging markets’ problems today: tightening global financial conditions stemming from rising US interest rates and a stronger dollar.

Thanks to years of near-zero rates following the global crisis of 2008, global debt levels are the highest on record. And thanks to the Fed’s gradual but steady rate-hiking cycle since late 2015, US Treasury yields and global borrowing costs are the highest since the crisis.

It’s a dangerous cocktail that Fed officials, despite their comments to the contrary, will surely take into account when deciding policy in the coming months. Will they raise rates twice again this year and three times next, as money markets suggest and policymakers themselves have indicated, if emerging markets are crumbling around their ears?

Mr Greenspan’s Fed cut rates in September, October and November 1998 as the Russian and Long Term Capital Management crises rocked world markets. The safe-haven Japanese yen rose 18% that October, its biggest monthly advance in 30 years.

Just as it was then, the US economy is now enjoying a tech-led boom, policymakers are baffled by low inflation, suppressed longend yields and the flat yield curve, and dollar-denominated debt across emerging markets is at a record high. For Turkey today, read Russia in 1998.

History rarely repeats, but it rhymes. The systemic risks may be lower today because the global financial crisis and subsequent tightened regulations have reduced leverage across the financial system. But the dollar may complicate the picture.

Dollar credit to non-bank borrowers in emerging markets is at a record $3.68 trillion, a burden that’s increasingly heavy to bear.

The dollar is up 8% since April, the 10-year Treasury yield is up nearly 50 basis points this year, and the two-year yield is up 75 basis points at a decade peak around 2.70%. Worryingly for these borrowers, the dollar is showing no sign of pausing for breath.