The Next (Financial) Wave

(It looks as if the next financial wave will be some form of foreign markets insolvency.)

Global finance faces $9 trillion stress test as dollar soars

… Contrary to popular belief, the world is today more dollarized than ever before. Foreigners have borrowed $9 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 $2 trillion in 2000. …

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 dollar index (DXY) has soared 24pc since July, and 40pc since mid-2011. This is a bigger and steeper rise than the dollar rally in the mid-1990s … which set off the East Asian crisis and Russia’s default in 1998. … (As a result,) companies are hanging on by their fingertips across the world. …

(Also, in China there is,) a $900bn “carry trade” – mostly through Hong Kong – that amounts to a huge collective bet on a falling dollar. Woe betide them if China starts to drive down the yuan to keep growth alive.

Manoj Pradhan, from Morgan Stanley, said emerging markets were able to weather the dollar spike in 2014 because the world’s deflation scare was still holding down the cost of global funding. These costs are now rising. …

The Institute of International Finance (IIF) calculates that the oil slump has slashed petrodollar flows by $375bn a year. Crude exporters will switch from being net buyers of $123bn of foreign bonds and assets in 2013, to net sellers of $90bn this year (further removing dollars from the marketplace.) …

It is possible that the Fed will retreat once again, judging that the world economy is still too fragile to withstand any tightening.(However,) the message from a string of Fed governors over recent days is that rate rises cannot be put off much longer … .

The most recent Fed minutes cited worries that the flood of capital coming into the US on the back of the stronger dollar is holding down long-term borrowing rates in the US and effectively loosening monetary policy. This makes Fed tightening even more urgent, in their view, implying a “higher path” for coming rate rises.

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