Dollar dependence sets the world up for liquidity crunch

Key feature of the global financial crisis a decade ago was a chronic shortage of dollars

The current run-up in US Treasury yields and the dollar poses a major stress test for a global financial system that has become even more dependent on the American currency since the last credit conflagration.

Mehul Daya and Neels Heyneke, strategists at South Africa’s Nedbank Group Ltd. who have analysed the role of the greenback’s liquidity in past crises, argued that “a stronger US dollar and the global cost of capital rising is the perfect cocktail, in our opinion, for a liquidity crunch” in a note.

Growth of credit in dollars

A key feature of the global financial crisis a decade ago was a chronic shortage of dollars that eventually spurred the Federal Reserve to set up swap lines with more than a dozen central banks to ease funding pressures. Yet, the world has doubled down since then: dollar credit to borrowers outside the US — excluding banks — climbed to 14 per cent of global gross domestic product by March, from 9.5 per cent at the end of 2007, according to estimates cited in a Bank for International Settlements paper.

Growth of credit in dollars has outpaced that of other foreign currencies in all major emerging-market regions, BIS (Bank for International Settlements) economists Inaki Aldasoro and Torsten Ehlers wrote in a paper last month.

Tail risks

That’s a danger given that “international bond investors tend to retreat quickly when US rates rise,” they wrote.

An appreciating dollar also “increases tail risks” for fund managers holding emergingmarket assets, they said.