Turkey has been in a currency crisis over the past weeks.
The Turkish lira has dropped more than 30% in a matter of days. Many claim that
statements from Turkey`s President Erdogan are to blame, but if you look
closer, you can see that there`s more than meets the eye.
Emerging markets have been heavily borrowing U.S. Dollars
over the past decade due to the low interest rates that were offered. Now that
the U.S. is increasing interest rates, and, even more important, is engaging in
Quantitative Tightening instead of Quantitative Easing, it becomes harder and
harder for emerging markets to pay back their debt. During the Quantitative Easing
period, the U.S. Federal Reserve (FED) was buying up bonds to revive the flow
of credit to a shrinking economy. Currently, the FED is doing the exact
opposite and is pulling out USD 40 Billion every month from the financial
system by letting these bonds mature and not replacing them. This means that
the supply of U.S. Dollars is declining, which results in higher demand (from
emerging markets) and thus higher prices.
As you have probably guessed, Turkey is the largest holder of U.S. Dollar denominated debt as a percentage of GDP, coming in at almost 55%.
Some of the countries on this list might still be lucky: they receive
lots of U.S. dollars because of their oil exports, or because of their trade
surplus with the U.S.
China has the largest trade surplus with the U.S. in the world and has
therefore always managed to easily pay off their U.S. denominated debt. This
trade surplus has always been seen by the U.S. as an unfair advantage for
China, especially because it seems like they control their currency and do not
want it to increase against the U.S. Dollar (The economics of supply and demand
dictate that when demand is high (trade surplus), prices rise, and the currency
appreciates in value).
Donald Trump has now tried to reverse this unfair advantage
by introducing tariffs on goods from China coming into the U.S.
China has retaliated not only by also introducing tariffs, but by lowering their currency against the U.S. Dollar. Do remember that the Chinese government is the world`s largest holder of U.S. Dollar reserves: USD 3 Trillion worth. Chinese corporations hold another USD 850 Billion. If China wanted to really retaliate against the U.S., they would sell it all and flood the market with these reserves, consequently crashing the U.S. Dollar. However, this would make their own currency more expensive, and thus crash their own exports. In my opinion they have created the best alternative that one can think of: the Belt and Road Initiative (BRI).
China has retaliated not only by also introducing tariffs, but by lowering their currency against the U.S. Dollar. Do remember that the Chinese government is the world`s largest holder of U.S. Dollar reserves: USD 3 Trillion worth. Chinese corporations hold another USD 850 Billion. If China wanted to really retaliate against the U.S., they would sell it all and flood the market with these reserves, consequently crashing the U.S. Dollar. However, this would make their own currency more expensive, and thus crash their own exports. In my opinion they have created the best alternative that one can think of: the Belt and Road Initiative (BRI).
The BRI is giving out loans to 68 different countries to
fund infrastructure projects. These loans have largely been in U.S. Dollars,
aside from their own currency, the Yuan. This initiative has started 4 years
ago but has really kicked off last year. Already, there are a few countries who
have trouble paying back their debt. I wonder if any collateral has been given
out for this debt? Sri Lanka had borrowed USD 1 Billion from China to finance a
port. The port has not been a success, and Sri Lanka couldn`t pay back their
debt. In exchange, they offered China a 99-year lease for debt relief.
From a macro perspective, China`s Belt and Road initiative
is hugely beneficial in three ways:
- They can make use of their U.S. Dollars without devaluing the currency.
- They put their own currency on the world map, in the hopes of becoming a reserve currency.
- If a debtor can`t pay back its debt, they will just take the collateral (ports, roads, mines) which can fuel their own economy in return.
Will Trump eventually win the trade war? He will definitely claim that he has, but I think China will have many more tricks up their sleeves. My prediction is that they will eventually both lose in this trade war, which will be amplified during the next economic downturn.
I`ll leave you with a great chart depicting the size of the
USD 63 Trillion in debt that the governments worldwide have accumulated.
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