The U.S. Federal Reserve drastically cut interest rates for over a decade to weaken the U.S. dollar exchange rate in order to make American exports more competitive and foreign imports more expensive. Cheap money and a depreciating currency incentivized emerging market companies to borrow 9.3 trillion in U.S. dollars. But with the Fed eliminating quantitative easing and other stimulus, the exchange rate of the U.S. dollar is strengthening, and the cost for foreigners to pay back “dollar loans” is rising. Strong dollar periods in the 1980s and 1990s caused emerging market financial crises. With the dollar appreciating, trillions in emerging market “dollar loans” may default.
From 2002 to 2012, the exchange rate of the U.S. dollar steadily declined by 38% as huge swaths of the domestic American economy were outsourced to contract manufacturers predominantly in China and other emerging markets. Despite the Fed’s $5 trillion of bank liquidity offered at historically cheap interest rates, U.S. industrial loan demand tanked, and then real estate lending collapsed once the 2008 financial crisis hit.
But with foreign companies desperate for cash and willing to pay high interest rates to fund a ramp-up of exports to the U.S., American banks, bond investors, and hedge funds loaned a record 2.3 trillion in dollars to foreign companies. Taking advantage of the trillions of dollars of Fed liquidity sloshing around in global money markets, foreign banks and bond investors lent another $7 trillion in “dollar loans” to foreign companies. At $9.3 trillion, foreign dollar loans exceed the entire GDP of China.
Because foreign borrowers assumed that the United States' competitiveness would continue to be crushed by cheap emerging market labor, they also expected to book a future profit when they paid off their loans with depreciated U.S. dollars.
But with the U.S. energy boom stimulating American economic competitiveness, the U.S. dollar has strengthened by 13% over the last two years, and the Fed has reduced its economic stimulus. The stronger dollar means foreign companies, mostly in Asia, now owe another $1.2 trillion in U.S. dollars on top of the $9.3 trillion they borrowed!Read the whole thing.