It is time to separate the facts from fiction on the possibility, if not probability, of a global recession. This writer believes we indeed may be on the brink of such a dire economic scenario; one linked to excessive borrowing by emerging market countries from China as well as other nations.
In light of this, the effects of the rise of the U.S. dollar must also be taken into consideration.
Over the last decade or more emerging market countries have borrowed heavily from China and others for infrastructure projects and other endeavors. Many of these emerging market countries possess faltering economies. Thus, they cannot pay back the massive amounts of debt they have managed to incur. Sri Lanka, Pakistan, Zambia, Ethiopia, and Serbia are just a few examples of emerging market countries with vast amounts of foreign debt that they cannot repay.
As emerging market countries continue to struggle with their repayment of debt issues, another matter has emerged to compound the pain. While tempered recently, the U.S. dollar has seen a historic rally over the last year against the Euro, British pound, Chinese yuan and other currencies globally. As of Sept. 19, 2022, the ICE U.S. Dollar Index, which measures the U.S. dollar against a group of currencies from the U.S.’s largest trading partners, rose by more than 14% since the beginning of 2022.
The U.S. dollar maintained a sizable advantage over other currencies into November.
As of Nov. 8, 2022, The Wall Street Journal Dollar Index, which measures the U.S. currency against a basket of others, showed the U.S. dollar up almost 15% since the beginning of 2022.
While the U.S. dollar gave up some ground late in 2022, it still closed on Dec. 29, 2022 up 8.4% for the year as measured by The Wall Street Journal Dollar Index.
As the Federal Reserve continues to fight inflation with interest rate hikes and by other means it is likely that this disparity in value of the U.S. dollar against other currencies will increase. With rising energy prices a distinct possibility, along with faltering economies globally, I believe that there will continue to be a flight to safety in the U.S. dollar and the U.S. dollar will continue to increase in value.
Attempts by governments and central banks in Europe, China, Japan and elsewhere to prop up their currencies through their own interest rate hikes and otherwise to defend against the rising U.S. dollar have largely failed.
The World Bank, U.N. Conference on Trade and Development and the International Monetary Fund (IMF) all recently indicated that the interest rate increases by central banks around the world could bring about a global recession. Further exacerbating this situation is that while the U.S. economy has faltered, it is actually in better shape than most economies globally.
Consider, when you couple a better U.S. economy with an increasing in value U.S. dollar, you have investors pulling money out of their home countries to invest in U.S. assets which have higher yields. Further complicating matters is that many emerging market countries have, over the years, increased their borrowing in their respective local currencies.
As economies have become unstable, countries have found that foreign investors have wanted out. Most of these countries were unprepared for this contingency of foreign investors pulling money out of their local currency debt.
The "investor exodus" has added pressure on emerging market currencies and inflated the value of their U.S. dollar debt.
This has resulted in a battle between foreign and local creditors and a resistance by some countries to restructure local currency debt. This entire scenario has led to problems with restructuring discussions with their lenders and the IMF.
The coupling of emerging market countries excessive borrowing and increase in disparity between the U.S. dollar and other currencies is a major problem. A significant issue exacerbated by the fact that the U.S. dollar is the world’s reserve currency, the currency in which many debt transactions are denominated.
According to the IMF, roughly 40% of the world’s transactions are done in U.S. dollars whether the U.S. is involved or not, a number this writer finds to be conservative.
Increasing the pain is that many of these loans, especially those from China, carry adjustable interest rates which have been and will continue to increase as borrowing rates around the world go higher.
As the U.S. dollar increases in value with respect to other currencies, it will increase the cost on debtor countries that have to first exchange their local currency into U.S. dollars which are used to pay back the debt.
While some of this debt can be restructured to alleviate a portion of the pain in the short-term for these debtor countries, it will not eliminate the problem in the long-term.
Also. the options for restructuring are limited. Rising interest rates are limiting the flow of private capital to emerging market countries.
Two alternative sources of capital have traditionally been the IMF and World Bank. Both institutions have seen record lending over the last few years, but there are limits to their capacity to lend.
With an increasing number of emerging market countries in distress, restructuring options will lessen and become more difficult. Further, some countries are in such bad shape that there is resistance to lending to them.
In summation, we must consider the facts and not be fooled by the fiction.
And that's my take.
Perry Kalajian is an attorney, consultant, and analyst with extensive experience in the areas of banking, finance, and restructuring. He possesses multiple degrees in each of the areas of business and law. Mr. Kalajian has had numerous appearances on Newsmax TV.
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