Currency Update for Steel Trading Nations as of December 11th 2014

The currency markets continue to be dominated by a strengthening dollar and a weakening of third world currencies in particular. Hyun Song Shin, who chief economist at the Bank for International Settlements in Basel, gives a lot of thought to the implications of the current situation. In recent presentations at the Brookings Institution, Mr. Shin documented the growing use of the U.S. dollar by borrowers and lenders outside of this country. U.S. banks and bond investors have lent $2.3 trillion outside the U.S. Foreign banks and foreign bond investors have lent much more: $6.5 trillion.

Here’s how Mr. Shin sees the world: “A manufacturer in an emerging market borrows in dollars, perhaps because it sells a lot of goods in dollars and sees borrowing in dollars as a hedge. A local bank lends the dollars, borrowing from some big global bank. When the emerging-market currency is strong and the dollar is weak, that manufacturer’s balance sheet looks sturdier–and the local bank sees that and lends more readily. Thus a weak dollar can lead to a global credit boom. When the dollar rises, though, all this runs in reverse, effectively tightening global financial conditions, particularly in emerging markets. The emerging-market currency falls. The manufacturer has trouble making payments on its dollar loans; so do its peers. Banks lend less readily. Capital investment stalls. Global money managers–the ones with lots of short-term wholesale deposits that search the world for the best yields–see a falling local currency and a weakening economy and pull money from the emerging-market banks. Then, global asset managers who had been lured by a high-growth story see that it is now over and do the same thing, selling emerging-market corporate bonds. That pushes up interest rates that businesses in emerging markets have to pay, and weakens them further in a vicious cycle. Long-term investors who don’t necessarily need to be leveraged can get burned when events in the financial markets translate into events in the real economy and cause a negative feedback loop,”