LONDON — If currency turbulence in emerging markets escalates into full-scale investor flight, the Federal Reserve may have a fresh headache in deciding when to slow its dollar printing policy.
Reuters
Given all the obvious influences on Fed policy — domestic inflation, jobless youths, long-term unemployment, stuttering credit creation or banking stability — gyrations on markets from Turkey to South Africa or South Korea may seem tangential.
But an enmeshing of the United States and the economies of the developing world since the turn of the century means the link between US monetary policy and currency runs on the other side of the world could be tighter than many assume.
Another financial shock now in emerging economies that use vast holdings of US Treasury bonds as capital insurance buffers could complicate a Fed exit from quantitative easing.
“As with so many previous emerging crises, although the Fed often triggers the withdrawal, it’s then forced to turn more accommodative by default as a result of the fallout,” said Simon Derrick, strategist at Bank of New York Mellon.
To avert the sort of protracted and devastating investment freeze they suffered in the late 1990s, economies across Asia and around the globe have built up huge hard-cash buffers as protection against future “sudden stops” in foreign financing.
Over the past decade, emerging economies have absorbed trillions of dollars of Western investment seeking higher growth and yields, while China’s historic emergence into the world economy has helped fuel a commodities “supercycle”.
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In buying up the incoming dollars, euros and other hard currency to prevent a rapid appreciation of their own local currencies, emerging central banks have amassed some $7,2 trillion in reserves.
That mirrors the estimated $8 trillion of private capital flows to emerging markets since 2004.
The International Monetary Fund (IMF) estimates more than 60% of that total is held in greenbacks, putting dollar holdings at about $4,4 trillion.
At least 80% of that — some $3,5 trillion — is banked in top-rated US bonds, mostly treasuries, IMF surveys suggest.
On those broad calculations, China alone holds about $1,6 trillion of US bonds, while the rest is spread far and wide across Asia to Russia, the Middle East and Latin America.
