Adrift in Debt - Part I

"So you think that money is the root of all evil? Have you ever asked who is the root of all money?" - Ayn Rand

As the world is awash with debt and dollars I decided to take a look at the impact that all of this is having on global growth.  If one considers that the financial crisis occurred in 2008 / 2009 you would expect that by now with more than USD 27 trillion of new capital issued by the central bankers of the world that the global economy would be booming.  Furthermore you would also expect that by now central bankers of the world would be fighting the inflationary pressures of low unemployment and capacity constraints by raising interest rates and tightening the money supply however, as we all know, this is not the case.  In fact the global market is so weak that the Federal Reserve decided that it could not handle even a ¼% increase!

Delving into the facts and figures brought me to the conclusion that it would be impossible to take all of this on in one blog (well actually I could have but I doubt anyone would read all the way to the end) so I have broken my findings into three.  The first blog published below will deal with the currency market, the second blog will deal with the global debt and the third blog will pull all the findings together in a conclusion that will provide some insight into what I believe the future holds.

In today’s world there is one currency that transcends all others and it is the United States Dollar.  Trillions of dollars of transactions occur around the clock and around the globe all denominated in dollars.  In fact in a recent report the Economist Magazine estimated that more than 60% of all global trade is conducted in dollars.  If one looks at the dollar market it can be broken into two pieces; those that are issued by the US Treasury and those created with a stroke of the pen in banks outside the United States.  These so called Euro or Asian dollars are backed by the bank issuing the dollars rather than by the US Treasury but they are still dollars and can be exchanged as real currency.  This second set of dollars used to be quite small in value but now estimates place the size of these “external” dollars at roughly 60% the size of those issued by the US.

The reason countries hold these dollars is for ease of trade but also to hedge against movements in the value of the dollar itself.  Back in 1997 when the contagion of the emerging market currencies was in full force countries decided that the best way to protect their currency was to hold a lot of dollar reserves.  These can be used to mitigate massive currency swings and also can be used to acquire strategic resources if the local currency devalues sharply.  The idea is that if you can control your currency swings you can control the level of economic growth.  This theory was put into practice and worked well for a while however recent events have shown that there is a problem with this theory; you are now open to the vagaries of the Federal Reserve.

As we have seen, with the US economy being the supposed shining beacon in a world of poor economic results, dollars can move easily back to the mother-ship stranding the emerging economies and destroying their currencies.  Furthermore as the dollar gains strength the commodities and inputs so desperately needed become more and more expensive crippling the local economy further.  At the very moment that the local country is hurting most the Federal Reserve raises rates creating further havoc in the local economy.  With the economy in tatters dollars pour out of the weak economy to the strength and higher returns of the USA and so the spiral continues.

We have already witnessed this to some degree as the currencies of many emerging economies have seen both their currency and their economies crater as the world waits to see if the Federal Reserve will raise rates.  For this reason the Federal Reserve has more control over the global markets than most people seem to realize which is why I have repeatedly mentioned that they need to look more globally when raising rates.  So while the US economy is losing ground as a percent of global GDP the Federal Reserve is still in control of a large portion of the globe's destiny due to the massive amount of trade handled in dollars and their veto power at the World Bank and the IMF (both of which are in a serious state of neglect and under funding).  Interestingly then at the time when the US so desperately needs to show global leadership they are more intent on political infighting and this will have a massively negative impact on global growth for years to come.