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Ambrose Evans-Pritchard: Experts fear IMF no longer has firepower to be world's lender of last resort
Well, there's always gold revaluation. See the old Brodsky and Quaintance hypothesis:
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By Ambrose Evans-Pritchard
The Telegraph, London
Sunday, February 9, 2020
Central banks have lost control of global liquidity. The dollarised international financial system has become treacherously unstable and vulnerable to a sudden reversal in capital flows.
Yet the International Monetary Fund is a diminished force and no longer has the firepower to act as the world's lender of last resort in an emergency. That is the stark conclusion of a G20 task-force of leading currency experts.
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A surge in offshore dollar lending -- increasingly through opaque security markets -- has exploded to $18 trillion and has overwhelmed the safety buffers of the existing financial architecture. The concern is that a continued surge in the value of the US dollar -- potentially triggered by the coronavirus epidemic, or any other black swan catalyst -- could bring this to a head.
"The risk of an unexpected and unplanned reversal of abundant global liquidity hangs over the world economy. Strong contagion across markets could make the endogenous dynamics of global liquidity very dangerous," the panel warned in an advisory report for G20 ministers, the Financial Stability Board and the IMF.
A decade of ultra-low interest rates and quantitative easing has flooded the globe with highly unstable forms of funding denominated in dollars, with no guarantor standing behind them. Glaring currency and maturity mismatches have accumulated.
This structure is prone to an abrupt "dollar crunch" should borrowers in China, east Asia, emerging markets, or even parts of Europe suddenly start scrambling for scarce US currency to repay bonds and loans in a crisis.
The report from the Robert Triffin International forum said the purely "private component of global liquidity" (defined as foreign currency credit to non-banks) has mushroomed to $12 trillion. This now dwarfs the shrunken $3 trillion pool of "official" liquidity, such as IMF resources, central bank swap lines, and even the eurozone bailout fund (ESM).
This private liquidity is highly geared to spasms of risk appetite and over-confidence, and even more geared to panic when trouble starts. It can snap back violently and set off potentially unstoppable chain reactions in a heartbeat. The liquidity is "destroyed" by forced deleveraging. Staircase up, escalator down.
"As the 2008 experience shows, the supply of private liquidity cannot be relied upon in periods of stress," according to the document by Bernard Snoy, Andre Icard, and Philip Turner, former top officials at the World Bank and the Bank for International Settlements.
They warned that there is no clear backstop if anything goes wrong. This is the Achilles' heel in the structure of globalised modern finance, the torment of regulators at their Swiss sanctum sanctorum in Basel.
The IMF cannot plausibly come to the rescue in a major upset. Its resources have dwindled to just 1 percent of global external liabilities, down from 4 percent in the 1980s, overtaken by the mushrooming scale of cross-border finance. "The IMF is not in a position to function as an international lender of last resort. The global financial safety net is too small," they said.
This is ominous since the so-called "balance of payments disequilibria" has become completely unhinged. "Global imbalances have now reached 40 percent of world GDP, an historical peak and four times larger than in the 1990s," they write.
Only the US Federal Reserve can print dollars and act as the guarantor of a deformed monetary regime at the mercy of dollar supremacy, or what the Bank for International Settlements calls the "global dollar system." Other central banks rely on currency swap lines from the Fed to shore up their own financial systems in an emergency.
It took some $600 billion of Fed swap lines to halt contagion during the Lehman crisis in 2008 when the wholesale capital markets froze and offshore dollar funding vanished. In other words, the Fed rescued the European Central Bank and saved the euro from an impending cataclysm -- though to this day few EU politicians understand what really happened.
However, Fed support -- while in principle still available -- ultimately requires the political assent of the U.S. Treasury and Congress. In Washington's current "America first" mood these so-called FX lines are seen by many on Capitol Hill -- and perhaps in the Oval Office -- as bailing out foreigners. There may be critical blockages or delays in a fast-moving crisis, allowing a Lehmanesque event to spin out of control. The IMF has issued just a warning.
Furthermore, key Fed figures from the Lehman drama -- including Tim Geithner and Ben Bernanke -- warn that post-crisis legislation such as the Dodd-Frank Act prevent the Fed from repeating such a rescue in extremis. Specifically, new rules limit emergency help for foreign entities.
The core global problem is the disturbing level of dependence on fickle dollar flows and shadow funding outside U.S. jurisdiction. The dollar's role has actually grown this century despite Europe's monetary union and the rise of China. Neither the euro nor the yuan have made a dent on dollar hegemony where it matters.
"Banks outside the United States currently have dollar debts which exceed the total liabilities of banks operating within the United States. Their dollar funding is vulnerable to any dollar liquidity shock," said the Triffin report. Under the IMF's measure, the volume has reached $18 trillion including swaps.
The BIS has a different gauge but the message is the same. Dollar credit to non-banks outside the U.S. has risen to 14 percent of global GDP from 10 percent at the top of the financial bubble in 2007. "The sharp rise in this ratio was seen as very dangerous even then," said the report.
This unstable regime is tested whenever the dollar strengthens, either because the U.S. economy is powering ahead faster than other big OECD economies (usually benign), or more treacherously when fear triggers a flight to dollar safety. U.S. Treasury bonds are the ultimate refuge, other than niche plays like the Swiss franc and the yen.
There are hints of this nervousness now as China's coronavirus leads to supply-chain disruptions for global manufacturing and as the eurozone's fragile recovery keeps disappointing. The dollar index (DXY) has spiked over the last five weeks to 98.70 and is nearing a 30-month peak. The Fed's broad dollar index is even higher today than at the top of the dotcom/dollar bubble in 2002.
This dollar squeeze tightens conditions for corporate borrowers in emerging markets -- often over-leveraged with short-term debt that must be repaid or rolled over. These debtors include Chinese developers with big dollar liabilities contracted on the Hong Kong funding markets but with no dollar revenues to act as a hedge. They are now being hit by a double whammy: a depreciating yuan and a financial shock within China from the virus lockdown.
While banks have stepped back since the Lehman crisis under draconian regulations and higher capital ratios, the risks have migrated to the offshore bond markets and opaque capital flows.
Huge sums are being channeled through exchange-traded funds and other instruments that promise investors liquid withdrawal at any time while locking the money into illiquid assets, a business model "built on a lie," in the words of Mark Carney, the outgoing governor of the Bank of England.
"Bond funds have made investors complacent about liquidity risks: they buy illiquid and high-yielding paper but quote daily prices to provide liquidity assurance ('liquidity illusion') to investors," said the Triffin report.
"The need to address the risk of a new dollar liquidity crunch is urgent. It is essential to develop adequate frameworks before trouble strikes," it said.
Is anything being done? Not much.
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