This crisis starts with a rising US dollar
As we have discussed in the past, I have contended that the primary error of the researchers in the financial alt-media is their insistence that the US dollar is in a structural bear market. Their reasoning was straight forward; the rising US Treasury debt levels would drag the dollar down into the abyss. The problem with this is that it is a linear analysis and fails to take into account the financial conditions of the other nations. The US has a comparative advantage and is better positioned to handle any upcoming debt crises that will come along.
Think about it; the US Fed is the only major central bank with the ability to actually restrict monetary policy. The other major central banks cannot even contemplate tightening monetary conditions. Despite the ever rising sea of red ink, the US is in a better position going into this next crisis. The emerging market economies will once again get hit hard. They are the most vulnerable to problems with dollar funding.
While investors have been focused on a strengthening U.S. dollar and rising Treasury yields, a weaker Chinese yuan also threatens to heap pressure on emerging market assets that have already wiped out their gains for the year.
That’s because a pause in the yuan’s appreciation path would challenge a clutch of developing economies by hitting their trade competitiveness against China, according to Morgan Stanley.
“RMB up and USD down is the best world in which you can live,” said Hans Redeker, the bank’s London-based chief global currency strategist. “You have it easier on exports and funding, all at the same time.”
Foreigners borrowing dollars are effectively shorting it
As of the end of 2017 the US dollar comprised about 63% of the world’s currency reserves. This huge pool of liquidity provides foreign investors with easy access to dollar-based credit. As long as the US dollar remained at a relatively weak level borrowers around the globe could rely on cheap funding with competitive interest rates (rates that were usually lower than in their home countries).
The risk of foreigners borrowing dollars to save on interest costs is that it exposes them to currency risk. Their debt liabilities, which are denominated in dollars, are not matched up with their revenue (either taxes or sales in a local currency). Thus, we can observe many emerging market crises that have their genesis with this phenomenon. If the expectation of foreigners is to pay back their dollar-based debt with ever softer dollars they may be in for a shock.
As the above mentioned Bloomberg article discusses, there is a concern that the US dollar may continue to rally at the expense of the Chinese renmimbi. If this is the case, China will become more competitive vis-a-vis the emerging economies at the worst time. The emerging economies have dollar-based loans to service and if their exports drop they will be squeezed on both sides.
The US will be the least affected from the upcoming currency crisis
Now isn’t that ironic?
The dollar rally is now rippling through emerging markets, sparking steep falls in stocks, bonds, and their currencies wiping out whatever gains they thought were guaranteed. We are looking a devastation around the globe with the Turkish lira falling almost another 6%. Argentina’s peso is also in trouble as the central bank raised the interest rate to 40% trying to support the currency.
The debts of governments around the globe are going to move up exponentially. This is very serious for some will raise taxes to try to keep the game going but that will cause even more deflation.
A number of analysts are calling for lasting stagflation, but the problem with this analysis is that it fails to take into account that the end users of the dollar (you and me) are not getting paid more and do not have more dollars to spend. The only way that there can be lasting inflation is if we began to receive direct pay raises and increases in benefit amounts. Based on the latest rounds of payroll data this does not seem to be taking place.
Furthermore, as Mr. Armstrong points out, rising tax rates from all sources is highly deflationary; it extracts from the tax payer’s spending power. As a result prices can only rise so far. The best cure for high prices is high prices. Moreover, as debt levels rise, the economic power is further drained and redirected to servicing more onerous levels of debt.
A rising dollar will hit Russia as well
Squeezed by ever-expanding U.S. sanctions, Vladimir Putin says he wants to dump the dollar. However, his central bank has been doing just the opposite.
In comments to lawmakers on Tuesday after his inauguration for a record fourth term as president, Putin said a “break” from the U.S. currency is necessary to bolster Russia’s “economic sovereignty,” especially in light of recent penalties and what he called politically motivated restrictions on trade.
According to the central bank’s latest data, the dollar’s share in its (Russia’s) international reserves climbed to nearly 46 percent in 2017 from just over 40 percent the previous year. Meanwhile, the euro accounted for almost 22 percent, sliding from more than 32 percent in 2016 and as high as 43.8 percent in 2009. The stockpile was at $459.9 billion in April, the highest since 2014.
Putin doesn’t have much to show for years of decrying the “dollar monopoly” that allows the U.S. to act like a “parasite” on the global economy. Now he has to contend with a deepening standoff with the U.S. after the latest round of sanctions in April ripped through Russia’s currency and stocks and cut off a major company’s access to Western financial markets.
While Russia is considered an emerging economy, as its economy is highly dependent on oil, a rising oil price will help its prospects and its ability to service its debt, especially its dollar denominated debt. Despite its anti-American rhetoric, Russia is taking appropriate action; it is increasing its dollar reserves at the right time.
The best scenario for the global economy will be for the US dollar to maintain its current value or depreciate slightly. This helps to keep dollar priced commodities reasonably priced, while helping the emerging economies export markets to remain competitive. If the dollar continues to rise all bets are off as debt deflation will overwhelm many areas of the globe and dollar-denominated debts will become increasingly unserviceable.
The people in the US will be the least likely affected by all this and may actually see some prices drop as import prices will begin to fade. But the falling row of global dominoes will end here in the US.