BERLIN — The dollar is strong, stronger indeed than it has been for years. Fears that the world's leading currency could implode are now over. Good news, right? Not quite. Paradoxically, it is precisely this overly strong dollar that could threaten the world financial system. A growing number of experts worry that a severe debt crisis in the emerging economies may be brewing.
If the value of the dollar continues to rise, it could lead to a wave of bankruptcies in Russia, Brazil and other emerging economies, which would have a serious impact on Germany and other countries that rely on exports.
Where and why did this potential threat arise? Countries, corporate entities and private households have, globally, become indebted to the tune of $10 trillion. A growing share of the debt has been incurred within emerging markets.
This debt could also become an existential risk. Most of these liabilities are not in native currencies like the Brazilian real or Russian ruble, but in dollars. In times of relatively stable exchange rates and a strong world economy with robust commodities quotations, this would not be such a serious problem: Dollar revenues on the world markets make it possible for dynamic economies to meet the cost of interest and repayment.
Within emerging economies, borrowing in dollars amounts to $2.6 trillion. Add to that $3 trillion in international bank loans, and that makes for a significant sum — approximately equivalent to Japan’s economic power.
The Basel-based Bank for International Settlements (BIS), a kind of central bank to the central banks, warns in its December 2014 Quarterly Review, that the appreciation of the dollar against the backdrop of divergent monetary policies could "have a profound impact on the global economy."
Hell breaks loose
Hans Redeker, chief currency strategist at Morgan Stanley notes that the money borrowed by the emerging economies is often used for domestic investments, so the balance sheets of many companies could be negatively impacted. Redeker fears that the crisis symptoms could play off each other, posing the danger of a chain reaction: "The BIS warnings confirm what we’ve been saying for a long time: Hell could soon break loose in the emerging markets."
Already now, the appreciation of the dollar is one of the strongest rises in past decades. The Dollar Index, which measures the greenback against the world’s major currencies, has been at its highest since spring 2006. But it's not the absolute state of the index that is noteworthy. It is the speed of the appreciation.
Since the beginning of July, the dollar has gained 13% on the major trade currencies, which for the currency market is huge. Against the currencies of individual emerging markets, the greenback's rally has been even more dramatic. Since summer, appreciation against the ruble is over one-third. It's 15% against the Ukrainian hryvnia and Brazilian real and 7% against the Turkish lira.
For companies whose debt in is dollars, that means that in their own currency their burden of debt keeps rising. And there's another troubling accounting problem: Many emerging economies overwhelmingly take in the dollars they need through the sale of commodities that are traditionally billed in dollars.
In the past few months, the dollar price for most commodities has taken a sharp dive. That mainly applies to the plummeting oil market, where prices have dropped some 40% since the summer, which is great for resource-needy industrial nations but poses an increasing threat to producers.
Dollar history lessons
Nearly one-fifth of the companies in the MSCI Emerging Markets Index are in oil-exporting nations. In the MSCI Frontier Markets Index, a sub-index for particularly dynamic economies, that's 55%. Signs of a potentially looming calamity are already reflected in the value of local stock exchanges. Since July the Frontier Markets Index has dropped by 8%.
The regular Emerging Markets Index lost 6% during the same period. The stock exchanges in industrial countries mostly gained, including record highs on the Dax and Dow Jones.
In the past, dollar appreciation has unleashed crises in emerging economies. It happened in the early 1980s when a strong dollar led the South American countries into major trouble and in the mid-1990s when the Asian tiger countries fell like dominoes.
Today China alone is indebted to the tune of $1.1 trillion, although the world's second-largest economy has significant dollar reserves amounting to nearly $4 trillion. They act like a kind of protective shield against crises. Beijing learned its lesson when, during the Asia crisis of 1997-98, it saw one government after another fall because the countries couldn't pay their dollar debt and fell into recession.
Ghana was the first country that had to be rescued by the International Monetary Fund. Africa's one-time star pupil was nearly bankrupt from the slump of its currency, the cedi, and dollar debt exploded.
The Ghana stock exchange — Photo: Dieu-Donné Gameli
It's a repeat pattern in the emerging economies. The government and companies borrow money in foreign currencies, which means local currency shocks have a dramatic effect. In economic literature, this is the phenomenon called "original sin." With their dollars, the countries inherit virtually all the problems of Wall Street.
In other countries this protective shield is far thinner: At first glance, Russia shows impressive foreign currency reserves of $361 billion, but it's all relative because their foreign debt is nearly double that, at $678 billion.
Brazil has $375 billion in foreign currency reserves with bank and company debt abroad amounting to $468 billion. According to BIS statistics, 63% of international debt is in dollars, with only 19% in euros and 8% in British sterling. The yen plays hardly any role at all at 3%.
The dollar, in other words, is as dominant as ever — and now its outsized strength could become a problem for the whole world.