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Abu Dhabi, UAETuesday 25 September 2018

End of easing by Fed throws up a new set of global risks 

Possible trauma to myriad economies, ranging from Chile to China and from South Korea to Saudi Arabia, where dollar liquidity has flowed in waves

The Federal Reserve's plan to unwind easing places an onus on those with huge dollar debt piles. AP /Richard Drew
The Federal Reserve's plan to unwind easing places an onus on those with huge dollar debt piles. AP /Richard Drew

The US Federal Reserve has signalled its intention to end the huge monetary easing it launched during the global financial crisis of 2008 to avert systemic financial collapse and a threatened repeat of the 1930s Great Depression.

But the Fed's action could court a new kind of financial crisis, many fear.

This is not just about shock to the US economy (although that may prove greater than expected) but possible trauma to myriad economies, ranging from Chile to China and from South Korea to Saudi Arabia, where dollar liquidity has flowed in waves, pushing up asset prices to bubble levels and fuelling an enormous borrowing binge.

Global financial markets have yet to catch up fully with the question of what happens once rising interest rates in the US and beyond come up against a towering wall of debt. "I think it's a profound question, which is not getting enough attention," says Charles Dallara, the former managing director of the Institute of International Finance (IIF), an association of over 380 global financial institution.

Some argue "that because the Fed has choreographed and telegraphed to markets its intentions [to end an era of cheap money] this is unlikely to have disruptive effects", the former senior US Treasury and IMF official tells The National. But Mr Dallara fears that once the tide of easy money ebbs it will expose ugly and dangerous debt wreckage lurking beneath the surface.

The world has plunged deeply, deeply into debt since the 2008 crisis,to the point where global debt has hit US$217 trillion, equal to a record 325 per cent of world GDP, according to the IIF, with $165tn of that being in mature economies and $53tn in emerging economies.

This debt build up has taken place right across the globe, among governments, companies and households and has been especially marked among business corporations in the world's leading emerging economies as well as among governments in mature economies. Much of the emerging market corporate debt, worryingly, is in dollars.

It is not hard to understand the causes of the debt binge. Interest rates have plunged to rock bottom levels (even negative in some cases) as central banks, led by the Fed, have used "quantitative easing" or QE to deliberately force interest rates down and them there since 2009.

They succeeded in these aims - but at a cost. With trillions of dollars of cheap money being pumped out by the US Fed, Bank of England, Bank of Japan, European Central Bank and others by way of government bonds and other financial asset purchases, interests rates have stayed on the floor.

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"According to economic historians, the interest [rate] level is as low now as in the 16th century," Japan's former vice finance minister for international affairs, Eisuke Sakakibara, tells The National. But the key question is,what happens now that the Fed has begun raising rates.

"I give the Fed full credit for managing the psychology [of throwing its huge monetary easing into reverse]," says Mr Dallara, who, while he was the head of the IIF in Washigton, was the point man for managing global banks' roles in the Greek crisis.

But, he says, there is the "supply and demand factor" to be taken into account as the Fed increasingly withdraws its purchases of Treasuries and other financial securities. Not only is the cost of money set to rise but there will be less of it around

"Already since markets have realised that the Fed is serious [about monetary tightening] 10-year rates have bounced up by 20 basis points [one fifth of a percentage point] and I think there is a good chance that we will see a gradual rise in rates regardless of when the Fed moves again."

A fractional rise in interest rates of this order may not sound scary but, as Paul Gruenwald, Asia Pacific chief economist at S&P Global Ratings in Singapore, notes, the impact of even marginal interest rates hikes could have a significant impact relative to current levels.

"If rates go from 4 to 5 per cent, that is an increase of 25 per cent but if they rise from 1 to 2 per cent that is an increase of 100 per cent," he observed in Tokyo last week. When viewed against the fact that global debt has soared to such record levels, this is worrying.

"For something to happen [by way of market reaction] it has to be a surprise," says Mr Gruenwald. "The Fed has been going slow and steady on rate increases. But the adjustment from 'expectation to reality' could be a shock if rates rise faster than expected.

"Stuff happens when it is not envisaged or priced in" by markets he adds. "What is not priced in just now is that there is a lot of new debt and debtors in the world - among firms, households and governments."

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Not everyone is overly concerned about this. Mr Sakakibara, for example, says that "debt levels all over the world have increased and not just in Asia".

"I am not particularly worried about it. We have now come to a period of low interest rates," he adds.

But Mr Sakakibara is in a minority in this regard. And, as 2017 has progressed, the chorus of voices warning about possible or even probable problems of debt crises ahead has grown to a crescendo among financial officials, prominent bankers and analysts.

David Rubenstein, the co-chief executive of the US private equity major The Carlyle Group, has warned of a repeat of the 1990s emerging-market crisis which forced then US president Bill Clinton to bail out Mexico. The Bank of Japan governor Haruhiko Kuroda also sees paralells with that crisis, triggered by US monetary tightening and a rising dollar against background of high US dollar debt such as exists now.

Government ministers including Japan's finance minister Taro Aso, the Indonesian finance minister Sri Mulyani Indrawati and Philippine finance secretary Carlos Dominguez, meanwhile, have all stressed the need for "vigilance" against a possible repeat of the 1997 Asian debt crisis.

The "speed and level" of debt growth is a source of special concern, Hung Tran, the executive managing director of the IIF has said, while the IMF chief economist Maurice Obstfeld has described the debt build up among emerging-market corporations as "worrying".

Fed tightening "will lead to credit tightening, at a time when we are facing higher debt ratios in most countries than before the Great Recession and when the current expansion from the 2009 bottom is the second longest in history," William Thomson, a former senior US Treasury and Asian Development Bank official, tells The National.

Mr Dallara notes, meanwhile, that "markets and the media seem obsessed with the exit from QE but they don't seem to realise that so many western governments, including the US, have incurred huge debt positions as a result of the huge increase in spending that took place in the first few years of the global financial crisis.

"If you look at the US alone the debt to GDP ratio at the sovereign level has almost doubled. In my view, markets have been a bit too sanguine."

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