Canaries in coal mines may flock to US dollar assets
In terms of liquidity, there is no deeper market than that of US government bonds.
Canaries in coal mines were used as carbon monoxide detectors. If the canaries toppled off their perch, the miners evacuated. With growing signs of distressed economic canaries, investors may feel the need to evacuate capital to the most liquid of markets and that may well mean US dollar-denominated assets.
In terms of liquidity, there is no deeper market than that of US government bonds, and in times of global uncertainty, investors tend to flock to that dollar-denominated asset class, even if yields are low, as the need to preserve capital trumps the desire for returns on it.
Of course, if US yields are on the rise, that is an added attraction.
In that latter vein, the stock of US data, allied to rhetoric from Federal Reserve policymakers, have recently led markets to mark up the prospects of a US rate hike in June or July, even as a number of economic canaries elsewhere in the world appear wobbly on their respective perches.
US polymath Benjamin Franklin once said that it was better to “go to bed without dinner than to rise in debt,” but across the globe many countries have gone to sleep well-fed only to wake to find they cannot pay their bills.
In the case of Greece, last Wednesday’s agreement for Euro zone nations did provide Athens with another 10.3 billion euros to help repay existing obligations.
But more importantly there was also an agreement for Greece to receive some form of debt relief in 2018 if it meets certain criteria, a date deliberately picked as it falls after next year’s federal election in Germany.
Of course the very acceptance that debt relief, which the International Monetary Fund had actually wanted to be front-loaded and not delayed, might be warranted implicitly recognises that Greece cannot live within the bailout terms previously agreed with its international creditors.
Elsewhere, years of rising public expenditure and debt accrual predicated on continuing high commodity prices have resulted in economic crisis in places such as Brazil and Venezuela as the fall in commodity prices has eroded income.
China may have thrown Venezuela a lifeline with an improved oil-for-loans deal, announced on May 17, but with triple-digit inflation and an imploding economy, the Caracas canary sits precariously on its perch.
Indeed, if the Fed does hike rates, triggering renewed demand for dollars and renewed weakness in dollar-denominated commodity prices, the plight of already over-stretched commodity producers can only become more acute.
Even Saudi Arabia is not immune although Riyadh’s policy of raising production to capture market share was a major reason for the oil price to fall in the first place.
Indeed, there have already been suggestions that the Saudis are considering using “I-owe-you” notes to pay bills owed to contractors, in an attempt to conserve cash.
With the Saudi riyal pegged to the dollar, some banks have even suggested that Riyadh might need to resort to either a devaluation of its currency against the greenback or even scrap the peg in favour of a Kuwait-style currency basket arrangement.
Those ideas might seem outliers given that the 1973 Riyadh Agreement commits Saudi Arabia to sell crude oil only in exchange for dollars, in return coming under the US strategic umbrella, but the very fact they are being broached only reinforces the scale of the challenges confronting the Kingdom.
And then there is China, whose total debt was 249 per cent of GDP in March, where the nominal size of that GDP is in excess of $10 trillion. That’s a lot of debt.
It may well be that policymakers in Beijing ultimately navigate a smooth passage for China’s economy but it would be remiss of investors to blindly ignore the possibility that there might be choppy waters ahead.
Investors may not necessarily want to increase their holdings of dollars but end up feeling they have to, especially if the knock-on effect of a new hike in US interest rates exacerbates the problems already being faced by alternative investment destinations and assets.
Some years ago, in the acclaimed US television series The Sopranos, one character declared his best friend was the face on the $100 bill, the same Benjamin Franklin quoted earlier.
With a number of economies around the world showing signs of distress, investors might again decide they too like the acquaintance of Benjamin Franklin as they choose to add to their holdings of US government bonds.