Wednesday, January 13, 2016

OMFIF Commentary - Danger of the Super Dollar

An interesting irony over the past few years has been how the US dollar has made a strong move higher (vs. other major currencies) while many had expected it to suffer a large drop due to monetary easing by the US Fed. On top of this, many analysts pointed out that the US Fed has been trying as hard as they can to get the US dollar lower all this time to get inflation up to their 2% target. 

It is pretty clear now that the surge in the US dollar is becoming an unwanted event by just about everyone. The consequences of this around the interconnected financial world are starting to show up in unwelcome ways as we have seen here in early 2016. The OMFIF (Official Monetary and Financial Institutions Forum) just published this new article entitled 'Danger of the Super Dollar'. Below are some quotes from the article and then some added comments.

"The dollar has reached its highest level since the early 2000s on a trade-weighted basis. This reflects higher US interest rates, expansive monetary policies elsewhere, and rising international tensions. The ‘super-dollar’ cheapens exports to America’s still world-beating economy, helping the world recovery.
But there is a considerable downside - the rising value of $7.6tn of dollar-denominated debt issued by international borrowers, mainly concentrated on emerging countries.
Strong economic growth and cheap credit in countries such as China, Brazil and Indonesia have driven governments, banks and large companies into massive dollar borrowing over the past decade.
As the credit tide turns, the volume of bad loans is likely to grow to dangerous proportions. For example, China’s non-performing loans are estimated at $630bn, roughly equivalent to Sweden’s GDP."   . . . . . . .

My added comments: If you follow all this news closely, you see that it's pretty clear that all the monetary easing that the US Fed and other central banks have been using over the last few years have really just been efforts to stave off a major deflation event. Former Dallas Fed President Richard Fisher just stated in a recent interview  that (over his objecting vote) the US Fed has apparently just created a big bubble in the stock market while failing to get the growth they hoped for in the real economy. A side effect of all this has been the explosion of debt in US dollar instruments (due to artificially low interest rates) in emerging nations around the world. As the OMFIF article points out, the continuing rise in the US dollar is causing big problems for all this debt and it has to stop soon or much bigger problems are likely to surface. Per the OMFIF article, " Banks and large companies in emerging economies face increasing costs to repay their dollar debts, just when their economies are in trouble."

Here is my take on this situation. The US Fed must find a way to contain the US dollar at some point  reasonably soon or risk the entire global financial system returning to significant instability. Raising US interest rates of course only makes the problem worse. My guess would be that sometime during this year (2016) the Fed will have to change course to try and get the US dollar lower somehow. All this probably means that precious metals (gold and silver) may catch a bid for the first time in several years later this year. If the Fed does not get the dollar down, they risk losing control of the entire system so they have to move that way at some point. If they succeed, gold will move higher as the dollar moves lower. If they fail, the entire system is likely to get more volatile and unstable. That would likely move gold higher as well. So gold may be ready to change directions sometime this year.
This year we need to follow what happens to the US dollar very closely. It simply cannot continue to surge higher without causing serious problems globally. How the Fed deals with this problem may be the biggest key to what happens this year in terms of monetary system change and stability. Tomorrow we look at a recent article by Jim Rickards that touches on this same issue.

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