The prospect of a stronger greenback is now a $10 trillion headache for the global economy. Borrowers who have loaded up on cheap dollar debt since the financial crisis could get into serious difficulty – especially if they don’t have enough U.S. currency revenue to repay creditors. The threat to financial stability is high.
The numbers are startling. Global banks’ international claims on the non-bank private sector – the sum of cross-border lending and foreign-currency loans extended by their local affiliates – has topped $9.5 trillion, according to the latest quarterly report from the Bank for International Settlements. In addition, non-bank private corporations in emerging markets have borrowed more than $500 billion on the international bond markets between 2009 and 2013.
The actual currency breakdown of these liabilities is unknown. But it’s safe to assume that a big chunk of the borrowings will need to be repaid in dollars. That could prove challenging. The greenback has surged 12 percent against a basket of major trading partners’ currencies since the end of June. An improving U.S. job market could see the dollar extend its climb in 2015.
Borrowers could find their debt burden rise in tandem with a strengthening dollar. In many emerging markets, domestic demand is weakening. At the same time, global growth remains anaemic, and prices of commodities – the staple exports of many developing nations – are in free fall. The sharper the rise in the dollar, the bigger the squeeze on borrowers in relatively poorer nations.
The risk of a debt accident is probably highest in China. At the end of 2008, global banks’ cross-border loans to the mainland accounted for just 6 percent of their total such exposure to emerging markets. That ratio has now soared to 28 percent. If faltering growth leads to capital outflows from the People’s Republic, causing the yuan to weaken significantly against the dollar, the repayment of the $1.1 trillion that Chinese borrowers owe to the rest of the world could come under a question mark. While policymakers in Beijing may have the tools to deal with local-currency defaults, a foreign-currency debt debacle in China could do serious damage to the global financial system. The $10 trillion headache would become a splitting migraine.
This view is a Breakingviews prediction for 2015. Click here to see more predictions.