It’s Not Just Turkey: There Is A Dollar Liquidity Storm Ahead Of Us

Experts are warning that 95 on the dollar index is the line in the sand, and we’re over 96 now. Here’s what experts say happens next…

by Brian Maher of Daily Reckoning

“It’s not just Turkey,” we are warned.

“The dollar liquidity storm is ahead of us — buckle up.”

Forewarned, we acknowledge Nedbank strategists Neels Heyneke and Mehul Daya for the advisory.

Where will it likely strike next?

Answer anon…

We begin with a brief excursion into the mysteries of the international monetary system… and the “Triffin dilemma.”

In 1959 Belgian-American economist Robert Triffin alighted upon a thumping paradox…

A nation boasting a global reserve currency carries a unique burden, he observed.

It must surrender partial control of its own monetary policy. It must also serve a global master.

That is, it must issue a superabundance of currency to lubricate the gears of global commerce.

Absent that continuous flow, the machinery could seize… and the world could sink into depression.

The issuing nation must therefore be willing to endure vast, sustained trade deficits.

The less wares the issuing nation buys from the world, after all, the less currency is available for global duty.

As the issuer of the world’s leading currency, this is precisely the burden the United States carries upon its shoulders.

Explains the IMF:

If the United States stopped running balance of payments deficits, the international community would lose its largest source of additions to reserves. The resulting shortage of liquidity could pull the world economy into a contractionary spiral, leading to instability.

The dollar accounts for some 87% of overall foreign exchange trades.

And over 60% of foreign exchange reserves are still held in dollars.

But the burden of global responsibility weighs with time…

The U.S. has endured an $11 trillion cumulative trade deficit with rest of the world since 1989.

Massive trade deficits are twinned with equally massive account deficits.

The United States ran a $466 billion current account deficit last year alone… accounting for 43% of all global deficits.

And its foreign debt swells to dimensions beyond all sustainability.

According to recent data from TreasuryDirect.gov, the government will shell out nearly a half trillion dollars for debt service this year.

A goodly portion of that amount it must pay to overseas creditors.

Thus what is “good for the world” eventually becomes a domestic bellyache.

As Investopedia notes:

[Ensuring global liquidity] causes a trade deficit for the currency-issuing country, but makes the world happy. If the reserve currency country instead decides to focus on domestic monetary policy by not issuing more currency, then the world is unhappy.

By this standard, the world is growing “unhappy.”

The world — especially emerging markets — fattened on record amounts of dollar-denominated debt during those heady days of zero interest rates following the Great Recession.

Atop this dollar debt these nations piled additional debt.

“This huge debt pyramid was fine,” Jim adds — “as long as… dollars were flowing out of the U.S. and into emerging markets.”

But that situation no longer obtains…

The Federal Reserve has been raising interest rates since December 2015.

And, as of last October, reducing its balance sheet.

The great flow of dollar liquidity is therefore slowing… even going into reverse.

A stronger dollar means higher interest payments for nations that took on dollar-denominated debt.

And investors are fleeing softer emerging-market currencies for the mightier dollar.

Fewer dollars are therefore available to service the world’s mounting debt and support local economies.

The result is an emerging-markets crisis, as is unfolding in Turkey… and Argentina.

Argentina’s central bank just raised interest rates to a crushing 45% in order to relieve pressure on its peso.

Emerging-market woes began appearing late last year after the Fed began working down its balance sheet — a process that continues apace.

Coincidence?

Not according to Urjit Patel, head of the Reserve Bank of India:

Global spillovers did not manifest themselves until October of last year. But they have been playing out vividly since the Fed started shrinking its balance sheet.

The danger of course is that the dam busts… and the current crisis spreads beyond Turkey.

“Forget about Turkey’s woes,” warn the aforesaid Heyneke and Daya.

What is the next trouble spot, in their estimation?

Asia.

“Asia is the elephant in the room.”

“We believe Asia will be the next source of downside systemic risk for financial markets,” they continue.

Why Asia?

Asian nations assumed the greatest amount of dollar-denominated debt since 2009.

Stay tuned… as they say.

Watch the U.S. dollar index, warn these gentlemen, which tracks the dollar against competing currencies.

Ninety-five is the red line. Anything above 95 spells trouble, they warn:

We cannot stress enough the importance of the 95 level on the U.S. dollar index. A confirmed break above this level will mark the beginning of the next risk-off phase.

What is the dollar index’s present reading?

96.67.

Forget About Turkey: Asia Is The Elephant In The Room

Back in November 2016, the BIS picked up on a topic we have often discussed over the years, namely the critical role that dollar abundance (or shortage) plays in defining market stress, and going one step further, published a research report which made the striking claim that while the VIX was now dead as an indicator of market risk, it had been replaced with the value of the dollar. This is what the Bank of International Settlement said then:

Just as the VIX index was a good summary measure of the price of balance sheet before the crisis, so the dollar has become a good measure of the price of balance sheet after the crisis. The mantle of the barometer of risk appetite and leverage has slipped from the VIX, and has passed to the dollar.

What explains the dollar’s role as the summary measure of the appetite for leverage? In a nutshell... there is a tight “triangular” relationship between (1) the dollar, (2) cross-border bank capital flows in dollars and (3) the deviation from CIP. The key to understanding this relationship is that dollar cross-border capital flows closely track the leverage decisions of global banks. The triangular relationship says volumes about the role of the US dollar in the global banking system, and ultimately how the monetary policy backdrop determines global financial conditions.

Fast forward to this June, when the head of the Reserve Bank of India, Urjit Patel, made a solemn appeal to the Fed: stop shrinking your balance sheet because in combination with the soaring US budget deficit (which requires a surge in new Treasury issuance), you are draining precious USD-liquidity out of the market.

This was the first time this cycle that a prominent foreign central banker accused the Fed of stirring trouble for emerging markets, with its ongoing tightening:

Global spillovers did not manifest themselves until October of last year. But they have been playing out vividly since the Fed started shrinking its balance sheet. This is because the Fed has not adjusted to, or even explicitly recognised, the previously unexpected rise in US government debt issuance. It must now do so.

Patel's advice? Immediately taper the tapering, or rather, the Fed should "recalibrate its normalisation plan, adjusting for the impact of the deficit. A rough rule of thumb would be to reduce the pace of its balance-sheet contraction by enough to damp significantly, if not fully offset, the shortage of dollar liquidity caused by higher US government borrowing."

Incidentally, the various pathways described by Patel were conveniently laid out by Deutsche Bank's Aleksandar Kocic earlierthis year, and which we explained in "Why The Soaring Dollar Will Lead To An "Explosive" Market Repricing."

Patel's punchline: if left unchecked, the EM turmoil "might hurt the US economy as well. Circumstances have changed. So should Fed policy. It would still reach the same destination, but with less turmoil along the way."

Two months later, the turmoil among emerging markets raging, with the currencies of Turkey, Argentina, Brazil, Russia and even China sliding against the dollar. So far the only part of his prediction that has not manifested, is the contagion from EMs to the US economy.

But that may be only a matter of time, especially if the Turkish crisis spills over into the European banking sector, and from there it crosses the Atlantic.

Meanwhile, focusing on the gloomy reality facing Emerging Markets - and their addition to dollars - is the latest note out of Nedbank's Neels Heyneke and Mehul Daya, who warn about the troubling fate facing EMs, writing that excess liquidity usually leads to the misallocation of capital, masking any balance sheet constrains. And as this tide of excess liquidity recedes it reveals the misallocation of capital and the mispricing of risk. The two caution that as EMs have benefited the most from this misallocation of credit, yet as the tide of excess liquidity recedes, "EMs will begin to pay the heavy price of this misallocation of credit." The "spread" between capital misallocation and reality is shown in the chart below.

Where we go full circle with the warnings from both the BIS and Urjit Patel, is that one way to monitor the ebb and flow of excess liquidity is by looking the changes in the value of the USD. As long as the dollar remains the reserve currency and most of the foreign owned debt is denominated in US dollars, for example in the carry trade, the dollar will remain king. Stated simply, "a weaker USD is associated with  a stable and healthy global environment whereby the global supply of USD’s is abundant. A stronger USD is usually associated with volatility and a risk-off phase as liquidity contracts" which is basically the point made by the BIS nearly 2 years ago.

As a result of Quantitative Tightening and rising interest rates, since the start of the year the supply of USDs has become scarce amid escalating tit-for-tat trade policies, slowing credit growth in China, and weaker commodity prices. This can be seen clearly in Nedbank's Global Broad $-Liquidity indicator, shown below.

Going back to Emerging Markets, while until recently investors were eager to attribute sharp drops in various EM nations to idiosyncratic factors, the recent widespread turmoil has become increasingly systemic. Confirming this, Nedbank notes that a number of studies have emerged pointing out that the role of global factors has increased relative to country/corporate specific factors.

This indicates that investors need to place more emphasis on the role of global liquidity (the changing pool of money and credit).

And while investor attention has been captivated by Turkey in recent weeks, Nedbank has some words of advice: "Forget about Turkey’s woes, Asia is the elephant in the room."

The reason is that South East Asia again stands out as in 1997/8, with a large amount of USD denominated debt outstanding. The only difference is then Asia had fixed exchange rates and now they are floating! Furthermore, Asia’s USD debt, relative to international FX reserves and exports, has risen significantly since 2009. This leaves these nations susceptible to a shortage in USDs (which would manifest itself in a sharply higher dollar price). Meanwhile, the Asian nations that have amassed record amounts of USD debt are also home to the largest technology companies i.e. Tencent (China), Alibab (China), TSNC (Taiwan), Samsung (S.Korea). The tech sector is now 28% of the MSCI EM index.

So between the rally in the US Dollar, dented global growth prospects, slowing Chinese credit growth and escalating political tensions from the US, leaves these nations very exposed to a shortage in USDs. Which is why, in Nedbank's view, "we believe Asia will be the next source of downside systemic risk for financial markets."

To be sure, one look at the chart below demonstrates that changing financial conditions have been the major driver of EM asset prices over the last several years.  The risk-on phase ended in January and all EM assetss old-off. EM-FX are however now taking the lead and the next few days will indicate whether this will spillover into the other asset classes.

So putting all of the above together, how to determine what happens next? Simple: keep an eye on the dollar... and stick the following EM contagion transmission chart on your wall:

If the dollar keeps rising aggressively at a time when China (which for now has a nice, thick capital controls firewall) is devaluing while other EMs are scrambling to contain capital flight by aggressively hiking rates (such as Argentina's shocking 45% rate hike yesterday) in the process sending their economies into recession, should the Fed fail to contain the dollar surge, the outcome may well be another Plaza Accord. But not before global markets crash first.

Fonte: qui

China Takes Another Step Towards The Collapse Of The Petrodollar

“China, along with a great many other nations, are ready for this system to change and balance the economic scale.” 

by Rory Hall of The Daily Coin

Ken Schortgen, Jr., The Daily Economist, recently penned an article about Nigeria approving a currency swap agreement with China, stating,

It has been a little more than a month since China officially began offering oil futures contracts denominated in the Yuan currency, but early results continue to be positive for this contract to over time take more and more market share from the West and the Petrodollar.  And with Iran, Qatar, and even Venezuela having already agreed to buy and sell their oil in currencies other than the dollar, a new currency swap agreement signed on May 3 between Nigeria and China could mean that a fourth OPEC nation could also soon be leaving the Petrodollar.

The Central Bank of Nigeria (CBN) has signed a currency swap deal worth about $2.5 billion with the People’s Bank of China to provide adequate local currency liquidity for transactions between national businesses, The Punch newspaper reported on Thursday, citing a high-ranking official from the Central Bank of Nigeria (CBN). Sputnik News

The Daily Economist

For the past year and half a major topic throughout the alternative press has been the new Chinese oil futures contract settled/priced in yuan. The fact that China is directly challenging the Federal Reserve Note, U.S. dollar, is quiet a significant change. For those that have been paying attention this new futures oil contract is nothing more than the next step in China moving completely away from the Federal Reserve Note, and the “world reserve currency” system and towards a multi-polar world with several currencies being used for international trade.

While China pursued currency swaps as far back as 1997, during the “Asian financial crisis”, none of the agreements were ever activated. That all changed with the global financial meltdown in 2008. China began actively pursuing, and instituting, direct currency swaps and even went so far as to open “Renminbi Clearing Centers” around the world including Canada, the backyard of the U.S..

Beyond the moderate progress in Asian regional financial cooperation, China has signed swap agreements with approximately 30 countries since 2008 (see Table 1). The People’s Bank of China (PBOC) stated that those swap agreements were intended not only to “stabilize the international financial market,” but also to “facilitate bilateral trade and investment.”

Table 1: China’s swap agreements and its counterparties

#	Countries	Signing Date	Swap Amount (RMB billion)	Trade volume(RMB billion)	RMB Clearing Center	RQFII
1	Belarus	May 2015	7	8.94
2	Malaysia	Apr 2015	180	652.66	√
3	South Africa	Apr 2015	30	401.25
4	Australia	Apr 2015	200	839.84	√	√
5	Armenia	Mar 2015	1	1.19
6	Suriname	Mar 2015	1	1.24
7	Pakistan	Dec 2014	10	87.46
8	Thailand	Dec 2014	70	438.29	√
9	Kazakhstan	Dec 2014	7	175.93
10	Hong Kong	Nov 2014	400	2,465.25	√
11	Canada	Nov 2014	200	335.01	√	√
12	Qatar	Nov 2014	35	62.60	√	√
13	Russia	Oct 2014	150	549.15
14	South Korea	Oct 2014	360	1,687.19
15	Sri Lanka	Sep 2014	10	22.27
16	Mongolia	Aug 2014	15	36.66
17	Switzerland	July 2014	150	367.42	√	√
18	Argentina	July 2014	70	91.28
19	New Zealand	Apr 2014	25	76.20
20	EU	Oct 2013	350	N.A.
21	Iceland	Sep 2013	3.5	1.37
22	Albania	Sep 2013	2	3.44
23	Hungary	Sep 2013	10	51.72
24	UK	Jun 2013	200	430.79	√
25	Brazil	Jun 2013	190	554.90
26	Singapore	Mar 2013	300	466.94	√
27	Ukraine	Jun 2012	15	68.43
28	Turkey	Feb 2012	10	136.79
29	UAE	Jan 2012	35	284.45
30	Uzbekistan	Apr 2011	0.7	28.00
31	Indonesia	Mar 2009	100	420.54
Total		–	3,137.2	10,747.2	–	–

CogitAsia

The chart above, from CogitAsia, was produced in 2015 and does include Japan, Nigeria or France all of which are conducting direct currency swaps with China. All three nations bring something unique, economically speaking, to the table that will prove beneficial for both sides of the trade.

China now has direct currency swaps with more than 30 nations, including some of the largest economies in the world, like Japan, France, Australia to name but a few. This is all part and parcel to circumventing the world reserve currency system which punishes other nations, while at the same time strengthens the U.S. economy. What’s terrible for the rest of the world is awesome for the U.S..

China, along with a great many other nations, are ready for this system to change and balance the economic scale. When you announce to the world that your currency is someone else’s problem, the people that have the problem usually find a way to mend the problem and eliminate the situation creating the problem.

Even the gloomiest pessimists accept that a steep dollar depreciation would inflict more suffering on China and other Asian economies than on the United States. John Snow’s counterpart in the Nixon administration once told his European counterparts that “the dollar is our currency, but your problem.” Snow could say the same to Asians today. If the dollar fell by a third against the renminbi, according to Nouriel Roubini, an economist at New York University, the People’s Bank of China could suffer a capital loss equivalent to 10 percent of China’s gross domestic product. For that reason alone, the P.B.O.C. has every reason to carry on printing renminbi in order to buy dollars. NY Times

This is exactly where we stand today. China, along with Russia, understand this scenario all too well. These two nations, along with 30+ other nations, are making moves to be rid of the problem known as the Federal Reserve Note, U.S. dollar. Once this “problem” is corrected the U.S. economy will change dramatically. Inflation, and according to some economist like John Williams of Shadow Stats, hyperinflation will reign down on the U.S. economy like the world has never seen or experienced before. At this juncture we can only hope cooler heads prevail and a major war doesn’t manifest to announce the coming change in our global monetary system.

Mathematically Assured Disaster: The Debt And Our Delusions Are Out-Of-Control

“Gold prices rise along with debt. Expect much higher gold prices as the “debt bomb” detonates.” Here’s why…

Quick summary: U.S. debt, spending and deficits are out of control. Thinking otherwise is delusional. The “runaway train” of debt creation will end tragically. Protect your assets from a mathematically assured disaster while you can. Buy and hold silver, gold and platinum.

The national debt of western nations plus Japan is a travesty that threatens national insolvency, a crashing financial system, and social stability!

WHY?

Governments spend more than they extract from their citizens. They borrow the shortfall, a virtual mortgage on the earnings of future generations. This is bad policy, delusional and self-destructive.

From Thomas Jefferson:

“I sincerely believe that banking establishments are more dangerous than standing armies, and that the principle of spending money to be paid by posterity, under the name of funding, is but swindling futurity on a large scale.”

From Herbert Hoover (President 1929 – 1933)

“Blessed are the young, for they shall inherit the national debt.”

Official U.S. government national debt (many other countries are no better) is the debt owed “on the books.” Unfunded liabilities, such as Social Security payments, Medicare, military pensions and upcoming student loan defaults are NOT included. The reality is far worse than indicated by the official national debt.

Plot 50 years of official national debt on a log scale. The trend is unmistakable. National debt has increased exponentially 8% – 9% per year. National debt doubles every eight to nine years.

Official national debt exceeds $21 trillion. Unfunded liabilities are $100 to $230 trillion, depending on who is counting.

BUT SURELY CONGRESS WILL ADDRESS THIS PROBLEM – RIGHT?

1. Name three reasons this 50 year exponential trend will reverse.
2. Name three congresspersons who want to reduce total spending.
3. Name three congresspersons who believe in a balanced budget.
4. Name one president who reduced spending or debt.
5. Name one “three-letter” agency volunteering to reduce their budget so the nation will be more fiscally responsible.
6. Name one defense contractor who wants to reduce their government contracts.

Give up? 0 for 12 is a strong sign that spending, debt, and deficits will increase until a reset occurs.

BUT SURELY OUR CONGRESS AND ADMINISTRATION ARE REDUCING THE DEFICITS EVEN IF THEY DON’T HAVE TOTAL DEBT UNDER CONTROL—RIGHT?

Well, no! The “debt ceiling” is a joke used for political purposes. Neither party wants to reduce spending or manage the nation’s resources.

Plot the deficits (national debt increases) year-by-year on a log scale. Some annual increases were larger than others due to wars, spending stimulus, extraordinary graft, and debt ceiling freezes, but the 50 year trend is clear—larger deficits. Since 1971 the exponential trend shows annual deficits increased on average per year.

(The reported “political deficit” includes only the items that congress wants to count.)

YES, THIS IS A PROBLEM. HOW DO WE FIX IT?

Doug Casey’s list follows. I discussed this topic here.

“In an ideal world there would be some radical changes. The best thing for the US in the (famous) long run is to go “cold turkey.” To abolish the Federal Reserve, fire its thousands of employees with their worthless PhDs. Return to 100% reserve banking with a strict separation of demand and time deposits. Depoliticize money by using gold, not Federal Reserve Notes. And default on the national debt, which is rewarding crony capitalists, and will turn future generations of Americans into serfs. And massively deregulate. And abolish the income tax, while cutting spending 90%. Etc. Etc.

The chances of that happening are exactly zero.”

Our financial system will not change until it collapses or resets, so we must adapt to its insanity.

It is a 5-D problem

• Debt has risen more than 8.5% per year, not counting unfunded liabilities. A 100+ year trend is unlikely to change.
• Deficits: The annual increase in the revenue shortfall has grown 14% per year since 1971, when President Nixon “closed the gold window” and let the dollar’s purchasing power collapse.
• Devaluation of the dollar occurs when the government and central bank create fiat dollars more rapidly than the economy grows. Have prices for steak, oatmeal, beer, cigarettes, new cars, prescription drugs, and political payoffs increased in the past 47 years? Yes, prices are far higher than when President Nixon separated the dollar from gold.
• Demographics: Baby boomers retire every day. Social Security payments and Medicare costs for them are skyrocketing. Expect larger budget deficits for many years.
• Difficult to correct:

1. Both Republicans and Democrats spend more money on pet projects and paybacks to donors.
2. The military wants more weapons systems.
3. Medicare costs are out of control and rising.
4. The U.S. government guarantees student loans. The national debt will increase as those loans default.
5. Congress passed a tax cut and spending increases which will boost the national debt.
6. The coming recession will lower tax revenues and increase other payouts.
7. Interest payments on $21 trillion of debt increase as rates rise.
8. The above will expand deficits and the national debt.
9. The U.S. government and the Federal Reserve have “painted themselves into a corner” with only difficult or next-to-impossible choices remaining, regardless of “happy talk.”

Politicians, presidents and central bankers will not admit they have mismanaged the government, devalued the dollar and created unpayable debt. Regardless, the problem is real, escalating every year and unsolvable. Few in government will discuss it.

In 1971 the price of gold was $42 per ounce. Today $1,330. The national debt in 1971 was $0.4 trillion. Today over $21 trillion. Examine this graph of national debt, the debt ceiling, and gold prices. Gold prices rise along with debt. Expect much higher gold prices as the “debt bomb” detonates.

CONCLUSIONS:

• Official national debt and annual deficits rise exponentially.
• There are few reasons to expect deficits to decline.
• There are many reasons to expect deficits to climb much higher.
• The dollar will devalue as debt and deficits rise.
• Gold and silver prices will rise as the dollar devalues. Their rally will spike higher as people realize the magnitude of the debt problem.

by Gary Christenson of Deviant Investor