Sadly, the end of easy money will not be as much fun as its beginning. Creating trillions of dollars from nothing and then taking them back does have consequences many of which we still have not seen
Central bankers are acting like over indulgent parents. They decry the over indulgence and irresponsible behaviour of their progeny, but continue to enable their activities. Larry Fink, the CEO of the world’s largest money asset manager, BlackRock, says, “You’re hearing from banking sources – whether it’s the BIS or the FSB or the Federal Reserve – a narrative that ‘there’s bubbles’, a narrative that ‘the private sector is guilty of investing in products that maybe lack long-term liquidity at interest rates that in the long run would probably represent some form of losses’. And the reality is, though, they’re to blame – and they’re not taking any of that responsibility.” The problem gets worse when you consider currencies.
Central bankers are not worried about the strong dollar. They feel that emerging markets were warned by the so-called taper tantrum in 2013. A senior official of the US Federal Reserve Bank said, “The emerging markets have had an entire year to think about the risks. We have signalled our intentions very clearly.” Then, of course, the Fed, the Bank of Japan and the European central bank created trillions of free money in the hopes that it would help their own economies grow. They should hardly be surprised that much of it found its way into emerging markets or that their ‘warning’ did much good.
The central bankers’ policies rewarded debtors and crushed savers. So savers had to hunt for yield in any place they could find it, often that was in emerging markets.
This could be a major problem similar to what happened in 1997. In that year a financial collapse known as the Asian crises occurred because of what has become known as “original sin”, the borrowing that is borrowing in a currency other than your own. Many commentators have written correctly that emerging markets have been issuing debt in their own currency to avoid the issue. But it still might not protect them.
While it is true that emerging markets have issued debt in their own currency, it is also true that they have issued quite a lot of it to foreigners. This is known as the carry trade. The exact size of the trade is unknown, but there are an estimate that it could be about $2 trillion of foreign capital has been invested in emerging market local currency debt.
As central bankers worked overtime to push interest rates to zero, their currencies declined as well. Investors in emerging market debt not only gained higher yield, they also benefited from currency appreciation. With successive quantitative easing programs (QEs) this has been going on for a long time, but all good things must come to an end.
QE in the US will end this month. The result is that the dollar is now at a 17 month high. Local currencies have started to decline (in the case of the Brazilian Real and Russian Rouble – plummet). According to the JPMorgan EMCI index, emerging market currencies have fallen below their 2007 low. When currency losses become higher than the interest rate advantage, the trade will unwind.
The other problem is that there is a lot of dollar debt out there. Exactly how much corporate debt is there and in what currency is not yet known. If you look at the amount of debt issued according to a country’s statistics and the amount of debt issued by companies, there could be a discrepancy of over 100%. Why? Much of the debt was issued off shore. For example, a Chinese coal company would not issue dollar denominated debt in China because it is illegal. Instead, they would sell bonds through Hong Kong. Therefore, the amounts are issue could be much larger than many economists now suspect.
The final problem is that this market is very illiquid. So as the US tightens interest rates, the dollar will appreciate further increasing the likelihood of an unruly exit.
Sadly, the end of easy money will not be as much funded as its beginning. Creating trillions of dollars from nothing and then taking them back does have consequences many of which we still haven’t seen.
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William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first-hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and speaks four languages.)
