The strength of the US dollar is having repercussions around the world, as emerging markets highlight the impact a strong currency can have on those in fragile financial situations.

Chelsey Dulaney writes in The the wall street journal:

“Emerging markets are burning stocks of US dollars and other foreign currencies at the fastest rate since 2008, raising the risk of a wave of defaults in the world’s most fragile economies.”

“Foreign exchange reserves of emerging and developing countries fell by $379 billion this year through June, according to data from the International Monetary Fund.”

“Excluding the effects of exchange rate fluctuations and the large foreign currency reserves of China and Gulf oil exporters, emerging markets are seeing the biggest declines since 2008…”

“Central banks around the world are using their reserves to defend their currencies against the rising US dollar and to cover higher import bills for food and fuel.”

“A perfect storm”, some people describe it.

Not only is the United States overseeing a rise in the US dollar to its highest level in twenty years, but the effects of the Covid-19 pandemic and the Russian invasion of Ukraine are also stretching these less well-off nations as they react to these great shocks.

Many of these emerging countries are asking for help from the IMF and others to help them through this crisis.

The fear is that with rising inflation, the world’s major central banks will raise interest rates and tighten financial liquidity and this will push some countries over the edge.

Many countries do not have enough reserves to begin with. Debt markets have closed to many more. And, market pressures appear to be spilling over to others as the fight against inflation spreads.

Again, we seem to be at a “tipping point” in history as the present world shifts into the future.

The monetary largesse of the past forty years may be coming to an end.

The United States was the root of this excess liquidity as it worked in the 1980s to recover from very severe monetary tightening to create an economic environment that would be sustainable for the rest of the century and beyond. .

The “credit inflation” produced in the 1980s and 1990s generated asset bubbles along the way, as lots and lots of credit was pumped into the US and global economies.

The spillover of Federal Reserve largesse throughout this period spilled over into the world.

Asset bubbles continued to form in the 2000s as the Fed kept its foot on the pedal and was followed by other central banks which began to emulate the Fed’s actions.

The Great Recession hit in December 2007 and lasted until June 2009.

Ben Bernanke, as Fed Chairman, led the United States into the next expansion, intentionally driving up stock prices to generate a “wealth effect” that would boost consumer spending.

It worked.

But Mr Bernanke continued to stimulate the economy with three rounds of quantitative easing that produced a booming stock market and a sustained period of economic growth leading to the Covid-19 recession.

Mr. Bernanke has always acted by favoring monetary easing during this period in order to minimize the possibility that the economy will be surprised and shaken again by an unexpected collapse or economic slowdown.

Mr. Bernanke’s successors continued to keep their foot on the accelerator pedal and emulated his desire to always err on the monetary side of ease in order to avoid any surprises along the way.

Internationally, many of these Fed-injected funds went into international coffers as massive amounts of debt spread internationally. Foreign central banks have prospered, as have foreign governments. The US dollar has spread all over the world.

Covid-19

The Covid-19 pandemic generated further monetary easing.

Jerome Powell, who took over as Fed Chairman, set out to ensure that the US financial system would not experience a major meltdown on his watch due to the pandemic, and so he followed his predecessors and created a monetary response to the situation that has surpassed those that came before it in terms of erring on the monetary side.

Under Mr. Powell, the Federal Reserve generated trillions of dollars of liquidity for the US and global financial systems. No financial meltdown was going to occur under his watch.

And dollars flew everywhere as financial markets accepted more and more debt issues from individuals, corporations and governments.

The period between 2020 and 2022 has seen more debt produced globally than ever before.

Whether you qualified for the debt or not wasn’t really the issue. Money was looking for places where people could use it. And the governments of emerging nations were not going to back down from this opportunity.

And, now we are on the next step.

I’ve written quite a few articles about the ongoing response among those who “lived off” the US debt boom and were now either in default or restructuring. Many real “stars” of the time are now scrambling, trying to stay alive.

What happens in this space is crucial for investors. How this segment of the business world is able to stay alive and not drag others down is crucial to our survival over the next two years.

Emerging countries

This is also very true of the debt markets linked to the borrowings of emerging countries.

We are on the other side of the story.

Excesses have occurred. The Federal Reserve was behind many of them.

Now it’s time to step back.

The Federal Reserve must fight this battle.

But, we all need to be aware of what is happening in this space.

And, other central banks should also be aware of playing a big role in this game.

I guess there will be a lot of pain felt.

The problem is that the Federal Reserve and other central banks cannot continue to get the amount of monetary easing wrong in this battle, because the other major threat these organizations face is inflation.

And that’s the payback of what these central banks have created before.

Inflation is a problem.

You have the Bank of England and the European Central Bank battling inflation that is already in double digits. And the problem extends beyond these organizations.

Central banks have a very fine line to tread moving forward and that’s combined with the Russian situation in Ukraine, the supply chain issues, the world’s transition to a technical base, China’s initiatives and many other smaller ones, but not least issues that need to be addressed.

We have to keep our eyes on the emerging market countries because something could happen there any day.