Blame of Clones - Season Three    

The Tail of America’s Central Bank

In Blame of Clones - Season One (link here), we discussed how monetary policy at our Federal Reserve has begun to diverge from that of the European Central Bank and the two central banks of England and Japan.  Season Two (link) dealt with tariffs and currency.  Here we'll take a look at monetary issues surrounding emerging economies.

So far this year, the U.S. dollar has been strengthening against a generic basket of other currencies, possibly awakening another threat.  Emerging market economies, in general, have little influence in the currency exchanges, due to their relatively small contribution to global trade.  These exporters can end up receiving less, after currency conversion into their local currency, as a stronger dollar makes the same quantity of goods received cheaper on our end.  This smaller relative clout also leads them into another difficulty, namely how to finance their domestic needs.

Borrowers in countries with less established financial markets may look to American banks and investors for loans.  Since financiers might not want to worry about currency fluctuations when dealing with a less developed economy, they often price the debt in dollars.  In return, the borrower is expected to pay accrued interest and ultimately the principal in dollars.  Here’s the rub.  If the dollar is appreciating (like it has been recently) these loans become more onerous to service.  In turn, this could make some of the less stable borrowers more vulnerable to default, especially since they are now earning less for the same amount of goods sold.

Debt issued by foreign entities but denominated in U.S. dollars is referred to as Yankee bonds.  The global debt market is now measured in the hundreds of trillions of dollars and Yankee bonds themselves are a part of that.  In fact, just over $338 billion worth were issued in 2017 alone.  If, as generally expected, our Federal Reserve continues to raise interest rates, the two issues raised above will likely grow more burdensome.

If only the issue was limited to that.  Yankee bonds aren't the only tail wagging this debt dog.  Adding to the total are so-called Samurai bonds denominated in Yen, Bulldog bonds in British pounds, and Eurobonds.  For many emerging market countries, a hard winter may indeed be coming.  If it leads to significant defaults, something even more ominous could begin stalking the financial landscape. (by Christopher and J R)