Every day we are presented with a myriad of economic statistics that can drown all but the most discerning of readers. Occasionally, however, we see one number that is so important and so significant in terms of potential future implications that it is worth pausing for some reflection.
A few weeks ago, The Wall Street Journal (WSJ) published an article titled “The New Bond Market: Bigger, Riskier and More Fragile Than Ever.” Within this piece was the following quote:
“Dollar credit to nonbank borrowers outside the U.S. hit $9.6 trillion this spring, the BIS said, up 50% from 2009.”
This is referring to debt that is denominated in US dollars and held by non-US, non-bank borrowers. And to put this $9.6 trillion into perspective, consider that the GDP of the entire Chinese economy in 2014 was $10.4 trillion, according to the World Bank. Put simply, this stock of dollar-denominated debt incurred by non-US borrowers is enormous!
The Bank for International Settlements breaks out the components of this debt by source region, as shown below. Perhaps not surprisingly, a full third of this debt has been incurred by emerging market borrowers – far more than what has been incurred by any other region.
Source: Bank for International Settlements
The thesis behind emerging market borrowers incurring US dollar-denominated debt was simple: US interest rates were low, and emerging market currencies were increasing. So the borrower wins on both the repayment of interest as well as the repayment of principal.
But as the Fed looks to tighten monetary policy in the US and emerging market economies begin to deteriorate, this strategy is starting to backfire. Instead of emerging market currencies appreciating, many have started to plummet against the US dollar. Just take a look at the Brazilian Real; or the Russian Ruble.
As the WSJ went on to note:
“Repaying those loans and bonds will become costlier in local-currency terms should the dollar rise, as it often does, when the Fed goes ahead with tightening, potentially stressing large borrowers such as emerging-market companies.”
Frankly, this is why the Fed is deeply concerned about the consequences on emerging market economies of potential monetary policy tightening. What are the potential consequences of defaults on US dollar denominated debt on global financial markets and real economies? This risk is surely one that was implied when the Fed stated it was “monitoring developments abroad” in September.