“The Dollar Liquidity Storm Is Ahead of Us”
“It’s not just Turkey,” we are warned.
“The dollar liquidity storm is ahead of us — buckle up.”
Forewarned, we acknowledge Nedbank strategists Neels Heyneke and Mehul Daya for the advisory.
Where will it likely strike next?
We begin with a brief excursion into the mysteries of the international monetary system… and the “Triffin dilemma.”
In 1959 Belgian-American economist Robert Triffin alighted upon a thumping paradox…
A nation boasting a global reserve currency carries a unique burden, he observed.
It must surrender partial control of its own monetary policy. It must also serve a global master.
That is, it must issue a superabundance of currency to lubricate the gears of global commerce.
Absent that continuous flow, the machinery could seize… and the world could sink into depression.
The issuing nation must therefore be willing to endure vast, sustained trade deficits.
The less wares the issuing nation buys from the world, after all, the less currency is available for global duty.
As the issuer of the world’s leading currency, this is precisely the burden the United States carries upon its shoulders.
Explains the IMF:
If the United States stopped running balance of payments deficits, the international community would lose its largest source of additions to reserves. The resulting shortage of liquidity could pull the world economy into a contractionary spiral, leading to instability.
The dollar accounts for some 87% of overall foreign exchange trades.
And over 60% of foreign exchange reserves are still held in dollars.
But the burden of global responsibility weighs with time…
The U.S. has endured an $11 trillion cumulative trade deficit with rest of the world since 1989.
Massive trade deficits are twinned with equally massive account deficits.
The United States ran a $466 billion current account deficit last year alone… accounting for 43% of all global deficits.
And its foreign debt swells to dimensions beyond all sustainability.
According to recent data from TreasuryDirect.gov, the government will shell out nearly a half trillion dollars for debt service this year.
A goodly portion of that amount it must pay to overseas creditors.
Thus what is “good for the world” eventually becomes a domestic bellyache.
As Investopedia notes:
[Ensuring global liquidity] causes a trade deficit for the currency-issuing country, but makes the world happy. If the reserve currency country instead decides to focus on domestic monetary policy by not issuing more currency, then the world is unhappy.
By this standard, the world is growing “unhappy.”
The world — especially emerging markets — fattened on record amounts of dollar-denominated debt during those heady days of zero interest rates following the Great Recession.
Atop this dollar debt these nations piled additional debt.
“This huge debt pyramid was fine,” Jim adds — “as long as… dollars were flowing out of the U.S. and into emerging markets.”
But that situation no longer obtains…
The Federal Reserve has been raising interest rates since December 2015.
And, as of last October, reducing its balance sheet.
The great flow of dollar liquidity is therefore slowing… even going into reverse.
A stronger dollar means higher interest payments for nations that took on dollar-denominated debt.
And investors are fleeing softer emerging-market currencies for the mightier dollar.
Fewer dollars are therefore available to service the world’s mounting debt and support local economies.
The result is an emerging-markets crisis, as is unfolding in Turkey… and Argentina.
Argentina’s central bank just raised interest rates to a crushing 45% in order to relieve pressure on its peso.
Emerging-market woes began appearing late last year after the Fed began working down its balance sheet — a process that continues apace.
Not according to Urjit Patel, head of the Reserve Bank of India:
Global spillovers did not manifest themselves until October of last year. But they have been playing out vividly since the Fed started shrinking its balance sheet.
The danger of course is that the dam busts… and the current crisis spreads beyond Turkey.
“Forget about Turkey’s woes,” warn the aforesaid Heyneke and Daya.
What is the next trouble spot, in their estimation?
“Asia is the elephant in the room.”
“We believe Asia will be the next source of downside systemic risk for financial markets,” they continue.
Asian nations assumed the greatest amount of dollar-denominated debt since 2009.
Stay tuned… as they say.
Watch the U.S. dollar index, warn these gentlemen, which tracks the dollar against competing currencies.
Ninety-five is the red line. Anything above 95 spells trouble, they warn:
We cannot stress enough the importance of the 95 level on the U.S. dollar index. A confirmed break above this level will mark the beginning of the next risk-off phase.
What is the dollar index’s present reading?
Below, Nomi Prins shows you why the emerging-markets crisis could worsen. Will it bring down the stock market? Read on.
Managing editor, The Daily Reckoning
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