Strong Dollar Bringing Emerging Nations To Edge

The strong U.S. dollar is having repercussions around the world, as emerging markets are highlighting the impact that a strong currency can have on those that have fragile financial positions.

Chelsey Dulaney writes in The Wall Street Journal:

“Emerging markets are burning through stockpiles of U.S. dollars and other foreign currency at the fastest rate since 2008, raising the risk of a wave of defaults across the world’s most fragile economies.”

“Emerging and developing nations’ foreign reserves have shrunk by $379 billion this year through June, according to data from the International Monetary Fund.”

“Excluding the effects of exchange-rate fluctuations and the large foreign-exchange holdings of China and Gulf oil exporters, emerging markets are seeing the biggest drawdowns since 2008….”

“Central banks around the world are using reserves to defend their currencies against the rallying U.S. dollar and to cover higher import bills for food and fuel.”

“A perfect storm,” some people describe it.

Not only is the U.S. overseeing a rise in the U.S. dollar to a twenty-year-high, the effects of the Covid-19 pandemic and the Russian invasion of Ukraine are also stretching these less-well-off nations as they respond to these major shocks.

Many of these emerging market countries are seeking help from the IMF and others to help them see their way through this crisis.

The fear is that with rising inflation, major central banks around the world will be raising interest rates and tightening up on financial liquidity and that this will push some countries over the edge.

Many countries don’t have enough reserves, to begin with. Debt markets have closed to many others. And, the market pressures seem to be spreading to others as the fight against inflation expands.

Again, we seem to be at a “tipping point” in history as the current world transitions into the future.

The monetary largess of the past forty years may be reaching an end.

The United States has been at the foundation of this liquidity surplus as it worked in the eighties to recover from very severe monetary tightening to create an economic environment that would be sustainable for the rest of the century and beyond.

The “credit inflation” produced in the 1980s and 1990s generated some asset bubbles along the way as lots and lots of credit was pumped into the U.S. and world economies.

The spillover of the Federal Reserve’s largess throughout this time period spread throughout the world.

Asset bubbles continued to be formed in the 2000s as the Fed kept its foot on the pedal and was followed by other central banks that began to emulate the actions of the Fed.

The Great Recession hit in December 2007 and extended through June 2009.

Ben Bernanke, as Fed chairman, led the U.S. into the next expansion, intentionally driving stock prices higher so as to generate a “wealth effect” that would stimulate consumer spending.

It worked.

But, Mr. Bernanke continued to stimulate the economy with three rounds of quantitative easing that produced a booming stock market and a sustained period of economic growth leading up to the Covid-19 recession.

Mr. Bernanke always acted to err on the side of monetary ease during this period so as to minimize the possibility that the economy might be surprised and shocked back into an unexpected economic collapse or downturn.

Mr. Bernanke’s successors continued to keep a heavy foot on the “gas” pedal and emulated his desire to always err on the side of monetary ease so as to avoid any surprises along the way.

Internationally, lots and lots of these Fed-injected funds went into international coffers as massive amounts of debt spread internationally. Foreign central banks prospered as did foreign governments. The U.S. dollar spread around the globe.

Covid-19

The Covid-19 pandemic generated further monetary ease.

Jerome Powell, who ascended to the chairman position at the Fed, moved to guarantee that the U.S. financial system was not going to have a major collapse on his watch due to the pandemic, and so he followed up from his predecessors and created a monetary response to the situation that out-did those that preceded him in terms of erring on the side of monetary ease.

Under Mr. Powell, the Federal Reserve generated trillions of dollars of liquidity for the U.S. and the world’s financial systems. No financial collapse was going to occur on his watch.

And, dollars flew all over the place as financial markets accepted more and more debt issues from individuals, businesses, and from governments.

The period between 2020 and 2022 saw more debt produced throughout the world than ever before.

Whether you qualified for the debt or not really was not the issue. Money was looking for places where people could use it. And the governments of the emerging nations were not going to back off from this opportunity.

And, now we are at the next stage.

I have written quite a few posts on the response now taking place amongst those who “lived” off the debt boom in the United States and were now either defaulting or restructuring. Many real “stars” from the period are now scrambling around, trying to stay alive.

What happens in this space is crucial for investors to watch. How this segment of the business world is able to stay alive and not pull others down is a crucial element of how we survive the next couple of years.

Emerging Nations

This is also very true of the debt markets connected with emerging nation borrowing.

We are on the other side of the story.

Excesses occurred. The Federal Reserve was behind a lot of them.

Now, it is time to back off.

The Federal Reserve must lead this battle.

But, all of us must be cognizant of what is taking place in this space.

And, other central banks must also be aware to play a big part in this game.

My guess is that there is going to be a lot of pain experienced.

The problem is, the Federal Reserve and other central banks cannot continue to err on the size of monetary ease going through this battle because the other major threat these organizations are facing is inflation.

And, this is the payback of what these central banks created before.

Inflation is a problem.

You have the Bank of England and the European Central Bank fighting inflation that is already in double digits. And, the problem extends beyond these organizations.

The central banks have a very fine line to walk going forward and this is combined with the Russian situation in Ukraine, the supply-chain problems, the transition of the world into a technical base, China’s initiatives, and many other smaller, but not little issues that must be dealt with.

We must keep our eyes on emerging markets countries because something could happen there any day now.