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Of course, this process is not independent of the global depression caused by the epidemiological situation, but its roots go much further back. The dollar is known to have become the world’s dominant currency since World War II, with a stable legal and institutional background in which even the Trump administration pushing its limits could not make a real gap. Consequently, the US currency has become the basic transaction and settlement tool for most developing and many developed countries. Countless countries and companies have borrowed in dollars by concluding other contracts in the same way. Of course, a major outflow of United States dollars was needed to have the right amount of dollars in the world, but the significant persistent balance of payments deficit and outflows of capital from the United States also helped, there was no real problem with the liquidity of the world dollar. Of course, during periods of crisis that occasionally erupted for decades, the flow of money to the US USA It caused interruptions in financing, but managed to address them, and the volume of dollar debt formed was not yet remarkably high.
Even without Covid the problems arose: slowing down globalization
While Chinese real estate developers, through Turkish mall builders and Brazilian speculators, owed a lot of dollars in the past decades, and many of these players didn’t even have dollar-denominated sales, the storm clouds have already started to build up. .
A new president, Donald Trump, has begun to radically subvert the established globalization-based international trading system, while in many countries, including China, corporate debt has already reached remarkably high levels, much of it in dollars. Of course, there are certain assets to the contrary, but they are illiquid and have uncertain ability to generate cash flow, especially in a slowing economic environment, while debt payment dates are relentlessly set.
The aforementioned US policy has also led to slower growth worldwide and serious financial problems, with many emerging market companies primarily reducing US export opportunities. But Chinese property developers, for example, have been forced to pay double-digit dollar interest rates in the short term due to oversupply. after debt This was due to increasing indebtedness and deteriorating sales prospects, so investors were only willing to give money to this sector with high returns.
However, let’s not forget one of the favorite forms of investment in the western world, credit purchases, where purchases have been carried out in recent years with an increasing debt / EBITDA ratio, which affects the balance of the target company with purchase price and credit. Both this multiplier and the volume of transactions reached a record high last year, that is, who knew how much more indebted they were.
Covid-19: fall into the abyss
It was then that the global coronavirus epidemic arrived, which was still “fueled” by a nominally fought, but in fact Russian-Saudi, price war against oil producers in the United States. World trade has historically collapsed, and within that, oil prices have reached unprecedented depths. Many companies and countries have been confronted with dollar-denominated sales while borrowing in dollars.
Looking at a simple example, an oil company was indebted in dollars, since it also planned to generate its future income in this unit of account. However, its sales declined suddenly, while its dollar-denominated debt fell not a penny, that is, in technical terms, it essentially entered a “short dollar.”
Furthermore, due to the collapse of US growth. In the US, demand for not only oil but other products has declined, meaning that far fewer dollars have flowed and will flow to the world in the future. The prices of many raw materials and finished products have also fallen. Because of this, we can talk about a problem much more general and bigger than the fall in oil prices, the largest “short position” in the world so far, that is, the global dollar deficit. How big can it be? Market views on this are divided, but the size of the total international dollar debt is generally set to more than 10 trillion, JP Morgan estimated in an analysis at $ 12 trillion. With normal corporate dollar cash flow, that would not be a problem, but past processes have found a big hole on the revenue side, analysts say this deficit could be billions of dollars in 2 -3 years.
Net global non-bank debt volume in foreign currency, in billions of dollars
What happens then? Due to the established unfunded position, many players desperately started buying the dollar, and emerging market currencies fell to double digits in a few months. The currencies of countries with minimal exposure in dollars have also fallen into “sympathy”, including the forint. Although Hungarian players’ unsecured debt in dollars is negligible, in a wave of sales in emerging markets, this was enough to prevent the national currency from being among the weakest.
The drop in exchange rates due to the monitoring of the emerging trend generates additional purchases, even speculative, in dollars, the above problem understandably attracts market participants who are looking for weak targets. Furthermore, the rainy exchange rate makes the financial burden on a country and its companies more expensive, which actually worsens the fundamental picture even more: negative feedback loops are formed.
What is the end of the process? Presumably, we will have to face many corporate restructuring events, that is, insolvency, even with further weakening of exchange rates and possibly state bankruptcies. This is further slowing global growth, which has been badly affected by the epidemic anyway. The process will come to an end when the improvement in the global cycle, or the most favorable events from an epidemiological point of view, change the market sentiment and a substantial improvement in the volumes of international trade begins.
What good news can there be in a situation like this?
An important factor is that developing countries’ foreign exchange debt is relatively small compared to previous crises, which is why, although many companies may become insolvent, government bankruptcies are less likely to completely curb international flows. of capital. At the same time, in addition to Argentina, there are already applicants for this in Africa.
The other is the active policy of the Federal Reserve. Decision makers of the US central bank. USA They are aware of the role of the dollar as an international unit of reserve and compensation, and although it is not the main driver of monetary policy, it is also addressing this problem. Mainly because the excessive strengthening of the dollar is also having a negative impact on the US economy. And the problem of massive growth and the possible balance of payments crisis in developing countries could affect the global financial system as a whole, including the US banking system. USA The Fed is trying to improve the liquidity of the international dollar through foreign exchange agreements with central banks in other developed countries, but based on the problem described above, it also seems that this is only a minimal symptomatic treatment, the main difficulty is insufficient cash flow from dollar debtors alone. Will remedy.
So the good news can only be that with the future improvement in the growth outlook, this shortage of dollars can be solved. But it won’t go away, and realistically, global trade volumes and dollar income levels are not expected to return in a year or two, as debt continues to tick.
How can this be evaluated from the investor’s perspective? Although the US currency has become very strong in recent months and is also explicitly overvalued on a PPP basis, it is still worth having dollars for hedging purposes if someone has otherwise risky assets in their portfolio. If global growth does not recover, the above problem will not be solved, the huge global position of “short dollar” will not be manageable, so the US currency can continue to strengthen, at least against other emerging market currencies. (The role of the euro, the Japanese yen, and the Swiss franc is different in this equation, with a number of other effects to consider here.)
If global growth improves dramatically, the dollar will weaken greatly, but in this case, any other item in the portfolio, such as stocks or real estate, can yield a good return.
Cover image: Paul Yeung / Bloomberg via Getty Images
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