Foreigners have borrowed trillions in US currency outside American jurisdiction. Photo / Bloomberg
Sitting on the desks of central bank governors and regulators across the world is a scholarly report that spells out the vertiginous scale of global debt in US dollars, and gently hints at the horrors in store as the US Federal Reserve turns off the liquidity spigot.
This dry paper is the talk of the hedge fund village in Mayfair, and the stuff of nightmares for those in Singapore or Hong Kong already caught on the wrong side of the biggest currency margin call in financial history.
"Everybody is reading it," said one ex-veteran from the New York Fed.
The report - Global dollar credit: links to US monetary policy and leverage - was first published by the Bank for International Settlements (BIS) in January, but its biting relevance is growing by the day. It shows how the Fed's zero rates and quantitative easing flooded the emerging world with dollar liquidity in the boom years, overwhelming all defences.
This abundance enticed Asian and Latin American companies to borrow like never before in dollars - at real rates near 1 per cent - storing up a reckoning for the day when the US monetary cycle should turn, as it is now doing with a vengeance.
Contrary to popular belief, the world is today more dollarised than ever before. Foreigners have borrowed US$9 trillion ($12 trillion) outside American jurisdiction, and therefore without the protection of a lender-of-last-resort able to issue unlimited dollars in extremis. This is up from US$2 trillion in 2000.
The emerging market share - mostly Asian - has doubled to US$4.5 trillion since the Lehman crisis, including camouflaged lending through banks registered in London, Zurich or the Cayman Islands. The result is that the world credit system is acutely sensitive to any shift by the Fed.
The Fed's so-called "dot plot" - the gauge of future thinking by Fed members - hints at three rate rises this year, kicking off in June.
The BIS paper's ominous implications are already visible as the greenback rises at a parabolic rate, smashing the Brazilian real, the Turkish lira, the South African rand and the Malaysian ringitt, and driving the euro to a 12-year low of US$1.06.
The dollar index (DXY) has soared 24 per cent since July, and 40 per cent since mid-2011. This is a bigger and steeper rise than the dollar rally in the mid-1990s - also caused by a US recovery at a time of European weakness, and by Fed tightening - which set off the East Asian crisis and Russia's default in 1998. Emerging market governments learned the bitter lesson of that shock. They no longer borrow in dollars. Companies have more than made up for them.
Stephen Jen, a former IMF official, says the latest spasms of stress in emerging markets are more serious than the "taper tantrum" in May 2013, when the Fed first talked of phasing out quantitative easing.
"Capital flows into these countries have continued to accelerate over recent quarters. This is mostly fickle money. The result is that there is now even more dry wood in the pile to serve as fuel."
Jen said Asian and Latin American companies were frantically trying to hedge their dollar debts on the derivatives markets, which drives the dollar even higher and feeds a vicious circle.
"This is how avalanches start," he said.
Companies are hanging on by their fingertips across the world. Brazilian airline Gol was sitting pretty four years ago when the real was the strongest currency in the world. Three quarters of its debt is in dollars. This has now turned into a ghastly currency mismatch as the real goes into free-fall, losing half its value. Interest payments on Gol's debts have doubled, relative to its income stream in Brazil.
Malaysia's 1MDM state fund came close to default this year after borrowing too heavily to buy energy projects and speculate on land. Its bonds are currently trading at junk level. It became a piggy bank for the political elites and now faces a corruption probe, a recurring pattern in the BRICS and mini-BRICS as the liquidity tide recedes and exposes the underlying rot.
BIS data show that the dollar debts of Chinese companies have jumped fivefold to US$1.1 trillion since 2008. Among the flow is a US$900 billion "carry trade" - mostly through Hong Kong - that amounts to a huge collective bet on a falling dollar. Woe betide them if China starts to drive down the yuan to keep growth alive.
Manoj Pradhan, from Morgan Stanley, said emerging markets were able to weather the dollar spike in 2014 because the world's deflation scare was still holding down the cost of global funding. These costs are now rising. Even Singapore's three-month Sibor used for benchmark lending is ratcheting up fast.
The added twist is that central banks in the developing world have stopped buying foreign bonds, after boosting their reserves from US$1 trillion to US$11 trillion since 2000.
The Institute of International Finance calculates that the oil slump has slashed petrodollar flows by US$375 billion a year. Crude exporters will switch from being net buyers of US$123 billion of foreign bonds and assets in 2013, to net sellers of US$90 billion this year. Russia sold US$13 billion in February alone.
China has also changed sides.
Liquidation of reserves automatically entails monetary tightening within these countries, unless offsetting action is taken. China has the latitude to do this. Russia is not so lucky, nor is Brazil. If they cut rates, they risk a further currency slide.
Powerful undercurrents in the world's financial system are swirling beneath the surface. Some hope that the European Central Bank's 60 billion ($85 billion) blast of QE each month will keep the asset boom going as the Fed pulls back, but this pushes the dollar yet higher. That may matter more in the end. It is possible that the Fed will retreat once again, judging that the world economy is still too fragile to withstand any tightening.
Yet the message from a string of Fed governors is that rate rises cannot be put off much longer. "All meetings from June onwards should be on the table," said the Atlanta Fed's Dennis Lockhart.
Nobody should count on a Fed reprieve this time. The world must take its punishment.
- Telegraph Group Ltd