Why the World Needs the US Economy to Struggle
By John Mauldin
Jan 04, 2015
The headlines this morning talk about the US dollar hitting an 11-year high. I have been saying for years that the dollar is going to go higher than anyone can imagine.
This trade is just in the early innings. And the repercussions will be dramatic, not only for emerging markets that have financed projects in dollars, but also for commodities and energy, gold, and a variety of other investments. The world is at the doorstep of a new era of volatility and currency wars.
On the Verge of a Disaster… or a Miracle
- The growing divergence among the world’s most important central banks
- The ongoing collapse in oil and other commodity prices as a function of excess supply and/or weakening global demand
- The rise of the US dollar, driven by divergence and risk aversion… and the squeeze it’s putting on the multi-trillion-dollar carry trade into emerging markets
- The vicious slide in emerging-market currencies
- The rising risk of 1990s-style contagion and financial shocks
- And what, if anything, can avert the next global financial crisis
Just as I had feared, the US dollar and Japanese yen were breaking out in opposite directions on real policy action, as Mario Draghi meanwhile continued to talk the euro down with the threat of future action. This may seem like a trivial shift in global FX markets, but it may have been the most important development we have seen since the global crisis peaked in 2008.
What did surprise a lot of economists (myself included) was the breakdown within OPEC, particularly Saudi Arabia’s willingness to accept whatever price the market offered in order to protect its market share. Conspiracy theories aside as to whether OPEC’s move constitutes an anti-American trade war against US shale producers or a pro-American squeeze on Russia, Iran, and Venezuela, it’s already putting a serious squeeze on Texas oil men, Russian “oiligarchs,” and oil-exporting emerging markets.
For readers who are unfamiliar with technical analysis, breaking out from a wedge pattern often signals a complete reversal in the trend encompassed within the wedge. As you can see in the chart above, the US Dollar Index has been stuck in a falling wedge pattern for nearly 30 years, with all of its fluctuations contained between a sharply falling upward resistance line and a much flatter lower resistance line.
I don't know if the Fed WILL hike interest rates this summer, but I do believe Chairwoman Yellen and Vice-Chairman Fischer INTEND to do so. And I think they are communicating their intention clearly for central banks around the world to hear. In his speech on the Fed and the global economy this past October, the vice-chairman (who, bear in mind, ran the IMF during the Asian Financial Crisis in 1997, the Russian default in 1998, and the related collapse of Long Term Capital Management) essentially said that clear communication is the FOMC’s only responsibility to the rest of the world:
Of course, intents and purposes can change. But after a year and a half of the Fed’s telegraphing its steady march toward the exits, US economic data remains remarkably robust, even if the strong dollar and the US shale slump eventually weigh on growth and employment.
Hyman Minsky taught that instability often emerges from the excess leverage and misallocation that naturally grow during long periods of perceived stability; yet central banks have now manufactured one of the longest-running periods of global market complacency in the modern era.
Despite the urgent need to get debt growth under control, the short-sighted combination of financial repression and excess liquidity has fueled overinvestment and capital misallocation in developed-world financial assets…
… but the real explosion in debt and financial assets has played out across the emerging markets, where the unwarranted flow of easy money has fueled a borrowing bonanza on top of a massive USD-funded carry trade.
In a recent presentation at the Brookings Institution, BIS Head of Research and Princeton University Professor Hyun Song Shin shared his research revealing that dollar-denominated credit to non-bank offshore borrowers is now more than $9 TRILLION.
While some of that new funding has come through equity issuance, the vast majority has come from bank loans and corporate bond issuance…
If you step back and take a look at how dependent many of the emerging markets have become on offshore bond issuance and/or cross-border loans, you’ll see that a number of countries are seriously addicted to foreign capital in one form or another.