A Crisis Reinforcement Channel Wakes Up

We have recently discussed the alleged “dollar shortage” with Mish and several others. The first thing that springs to mind when hearing of a “dollar shortage” is this: why should there be a shortage of a fiat currency that not only can be printed at will, but the supply of which has in fact more than doubled since early 2008?



Photo credit: Christopher Furlong/Getty Images


Of course those who are in a sense short of dollars are the many dollar borrowers abroad, who need to service a $8.6 trillion debt load. Here is a chart published by the BIS we have shown previously:


1-BIS-dollar-credit-to-nonresidents-by-sourceStock of dollar loans issued to non-banks abroad (lhs), annual growth rate (rhs).


To the extent that these dollar borrowers have income that is not denominated in dollars, they may indeed be in trouble now, as the dollar’s exchange rate has relentlessly soared. This incidentally slows down the accumulation of dollar reserves by central banks in countries with a mercantilistic economic policy (since they don’t feel the need to weaken their currencies anymore).

Over time, this should work as a counterweight to the dollar’s strength, as domestic money supply growth in these countries will tend to slow down as a result. In addition, other currencies are currently beginning to replace the US dollar for new borrowings. These days the euro and the yen have become popular funding currencies – initially, this tends to exacerbate the price trends that are already in place, but at some point, the problem currently faced by dollar borrowers will migrate to euro and /or yen borrowers.

What is quite interesting is where the majority of dollar borrowers are located. Most are actually domiciled in emerging markets, the currencies of which have been especially weak. So there undoubtedly is a problem, but as we will explain below, the problem shouldn’t be termed a “shortage”.


2-BIS-dollar-credit-to-nonresidents-by-geographyMost dollar borrowers outside of the US are located in emerging markets


In the discussion alluded to above, we made the following remarks (which were in part already published by Mish), to which we add a few additional thoughts below:

The visible currency effects (such as a soaring dollar exchange rate and funding gaps, see below) are usually mainly a consequence, not a cause of crisis conditions. Of course, the recent rise in the dollar was initially triggered by perceptions of monetary policies between the US and other currency areas diverging – everybody expects the Fed to hike rates, while rates are being lowered everywhere else. It should be added to this that there are of course feedback loops at work: the stronger the dollar becomes, the more difficult it will be for dollar debtors abroad to service their debt, so any future crisis situation will tend to feed on itself. Note in this context that if a debtor has hedged his dollar exposure, the associated currency risk has not disappeared – it has merely been shifted to his counterparty.

As can be seen from the charts above, borrowing in dollars has increasingly been effected via bond issuance in recent years – however, although their share of dollar loans abroad has decreased, bank loans extended to overseas borrowers have still continued to grow. If funding of dollar assets was a problem in 2008, it would be an even bigger problem today if a crisis that once again creates major distrust among financial intermediaries were to hit.


A Shortage of Dollars?

There are large amounts of dollars held in deposits abroad (mostly in Europe), and fractionally reserved banks are of course lending them out. They routinely have sizable asset/liability maturity mismatches (banks do lend out money held in demand deposits after all, which is the “ultimate” maturity mismatch), but this is true of banks everywhere, regardless of the currencies employed.

Prior to the central bank swap arrangements (this is in reference to the dollar swap windows the Fed has established with numerous central banks abroad), overseas based commercial banks could not turn to their own central banks for “lender of last resort” services with respect to funding of dollar assets when dollar deposits suddenly fled (US money market funds are e.g. a major source of these dollar deposits, and they pulled back when the US mortgage credit bubble blew up).

This concern is by now academic, since the swap lines now do exist, and are theoretically unlimited. Incidentally, US taxpayers have not suffered any harm, as all the swaps have been paid back (and even if they hadn’t been paid back yet: no-one was actually “taxed” to create them. The money was created from thin air, with the push of a button). The chart of central bank liquidity swaps below also supports our above contention: dollar funding problems in overseas banking systems are primarily a consequence, not a cause of crisis conditions.


3-Central Bank dollar swapsEvolution of central bank liquidity swaps – click to enlarge.


As noted above, the largest amount of dollar deposits held abroad is located in Europe. European banks are therefore also the biggest lenders in dollar credit transactions between non-US residents. They are also the biggest lenders to emerging markets in general, so any problems there are bound to impair the situation of European banks. In fact, three quarters of all dollar-denominated lending to non-US resident borrowers is funded with dollars held abroad – only one quarter comes directly from US lenders.

We currently see euro basis swaps trading in negative territory again, which is indeed an indication that dollar funding conditions have tightened. Shorter term basis swaps have not deteriorated as much as the longer term ones – usually, when there is really a big problem, the shorter maturities will move into negative territory at almost the same pace (this is just an empirical observation). This may yet happen with a lag though.

Something is definitely stirring though – and it happens concurrently with the euro showing extraordinary weakness and in concert with on-and-off market concerns about the situation in Greece (although we would argue these concerns are more “off” than “on”, so they may only be playing a small role. It is of course a role that harbors some potential to become bigger).


4-Euro basis swapsThree month, one year, three year and five year euro basis swaps -diving into negative territory again – click to enlarge.


As noted above, there are approximately $8.6 trillion in dollar-denominated debt outstanding abroad, a not inconsiderable amount. The basis swap “penalty” rate evident in euro basis swaps could be an indication that there is now a measure of distrust in the system: dollar lenders need to be recompensed for taking credit risk. The actuarial value of the fx basis should normally be at zero – if it isn’t, something is amiss. The main reason for the fx basis to drift into negative territory are usually concerns about the creditworthiness of banks.

Readers who want to learn more about short term swap markets can download a guide by CS (pdf) we have made available for such occasions. In addition to this, here is a recent document by JPM (pdf) that discusses the current signs of growing dollar funding difficulties (referred to as a “shortage” throughout, but we believe this is not the best choice of words. “Funding gap” is perhaps better). JPM argues that since no banking crisis is in evidence, the perceptions about diverging central bank policies must be the main reason for the developing supply/demand imbalance. We are not entirely sure about this though.

Per experience, euro basis swaps will decline deeply into negative territory before European banks will apply for funds from the Fed/ECB swap window, since the funds provided by central banks via these swaps don’t come for free either. In fact, they are relatively expensive if memory serves, which means that once one sees banks borrowing from this facility, the situation is probably quite dire already. Obviously, since the amount of central bank liquidity swaps currently outstanding is at zero, there is no evidence yet of an acute funding problem. What there is are however the first smoke signals that something of this sort could soon be afoot.

We think it is actually not quite correct to speak of a “dollar shortage” in this context. The domestic US dollar money supply has more than doubled since 2008 (in terms of TMS-2), and a sizable amount of dollar creation has “escaped” into accounts held abroad as well (read: the dollar money supply held outside of the US has also increased). It is not a shortage of dollars, but a growing unwillingness of dollar holders to lend them out that could create a problem for banks in need of dollar funding.


Bond Issuance vs. Bank Lending

Most of the new dollar lending to overseas borrowers has happened via bond issuance, and banks have shut down a lot of their proprietary bond trading due to new regulations and have cut back mightily on assets with a risk weighting higher than “zero” in order to comply with higher tier one capital requirements (this can sometimes backfire, as in the case of senior “guaranteed” Heta bonds). Given all this, should it not be assumed that any crisis in the context with dollar debts of overseas borrowers would be of – relatively speaking – little concern to banks?

The biggest losses would after all be suffered by investors in these bonds, most of whom are non-banks. However, this argument overlooks the interconnectedness of credit markets. Banks could find themselves affected indirectly. A borrower who defaults on a dollar-denominated bond and is forced into bankruptcy will also default on his other debts – and these will invariably include many bank loans. Many investors are in turn borrowing funds to leverage their investments in bonds. With interest rates at rock bottom levels everywhere, ample leverage is reportedly employed to juice returns.

Moreover, what is commonly referred to as the “shadow banking system” is also interconnected with banks. Losses in corporate bonds (which don’t necessarily have to stem from defaults – a rise in rates for whatever reason could already produce painful losses for leveraged investors and would set off a wave of forced selling) will reverberate across the financial system. Note that the fact that banks are no lonfer as active in corporate bonds as they once were is likely to greatly exacerbate volatility.

How things will precisely play out when the next financial crisis arrives is not knowable in advance. There are always surprises, and all we know with certainty at this point is that the next crisis will look different from the last one. For instance, even during the mortgage credit crisis several flashpoints of the crisis were undoubtedly a surprise for most market participants (think e.g. about AIG’s credit default swap portfolio blowing up – no-one expected this in advance to our knowledge).



There are some indications that trouble could be on its way as a result of the soaring dollar. This is something that certainly requires close watching now, as one (of many) potential triggers for pricking the bubble. The main fount of bubble conditions, money supply growth, still seems to be in fine fettle for the moment, but we know that the current boom is to some extent fundamentally different from a “normal” boom, in that it is far more concentrated in financial markets, so one will have to be careful with the interpretation of various data. We will discuss this particular aspect in greater detail in our next installment of the “Echo Boom” series (coming soon). Stay tuned.



The dollar index continues to go parabolic … to the chagrin of dollar borrowers not resident in the US – click to enlarge.


Charts by: BIS, St. Louis Federal Reserve Research, Bloomberg, StockCharts.

Emigrate While You Can... Learn More



Dear Readers!

It is that time of the year again – our semi-annual funding drive begins today. Give us a little hand in offsetting the costs of running this blog, as advertising revenue alone is insufficient. You can help us reach our modest funding goal by donating either via paypal or bitcoin. Those of you who have made a ton of money based on some of the things we have said in these pages (we actually made a few good calls lately!), please feel free to up your donations accordingly (we are sorry if you have followed one of our bad calls. This is of course your own fault). Other than that, we can only repeat that donations to this site are apt to secure many benefits. These range from sound sleep, to children including you in their songs, to the potential of obtaining privileges in the afterlife (the latter cannot be guaranteed, but it seems highly likely). As always, we are greatly honored by your readership and hope that our special mixture of entertainment and education is adding a little value to your life!


Bitcoin address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke


3 Responses to “The Dollar Squeeze – How Problematic Is It?”

  • ManAboutDallas:

    Doesn’t anyone see the similarity between the current US$ blow-off top and the one silver put in back in April of 2011?? Line up the charts, for heaven’s sake; they’re veritable twins.

    And the US$ will suffer the same fate as silver and every other parabolic, blow-off top every market experiencing such an occurrence has suffered since the dawn of markets, and blow-off tops.

    No, it’s NOT “…. different this time.”

  • No6:

    No Dollar shortage but there is a collateral shortage for all those derivatives now looking very shaky.

  • FoolsGold:

    This is one of the better pieces I have read in recent months and years regarding this issue and I want to point out that while assets lately have fallen in terms of dollars, bitcoin has not…Bitcoin has kept pace and in fact increased even as gold and silver sells off….

    The premise of Fed policy – that tech keeps up with money printing – is flawed and will feed the very problem you explain.


Your comment:

You must be logged in to post a comment.

Most read in the last 20 days:

  • 5-cotmmrangegc03Ganging Up on Gold
      So Far a Normal Correction In last week's update on the gold sector, we mentioned that there was a lot of negative sentiment detectable on an anecdotal basis. From a positioning perspective only the commitments of traders still appeared a bit stretched though, while from a technical perspective we felt that a pullback to the 200-day moving average in both gold and gold stocks shouldn't be regarded as anything but a normal - and in this case actually long overdue -...
  • gold_bullionGold Sector Correction – Where Do Things Stand?
      Sentiment and Positioning When we last discussed the gold sector correction (which had only just begun at the time), we mentioned we would update sentiment and positioning data on occasion. For a while, not much changed in these indicators, but as one would expect, last week's sharp sell-off did in fact move the needle a bit.   Gold - just as nice to look at as it always is, but slightly cheaper since last week. Photo via The Times Of India   The commitments of...
  • wryAustralian property bubble on a scale like no other
      Australian property bubble on a scale like no other Yesterday Citi produced a new index which pinned the Australian property bubble at 16 year highs:   Bubble trouble. Whether we label them bubbles, the Australian economy has experienced a series of developments that potentially could have the economy lurching from boom to bust and back. In recent years these have included:    the record run up in commodity prices and subsequent correction;  the associated...
  • "What if we don't change at all ... and something magical just happens?"Prepare for the Unthinkable
      Red Ink Growth and profits mask a variety of problems.  They hide business inefficiencies and the money suck of corporate adminis-trivia.  They also conceal unproductive staff.   The final career leap   But most of all growth and profits obscure the extreme value subtracting forces of bloated management teams.  During good times it is unclear what these smug fellows do.  During bad times it is lucidly clear that most of them ain’t worth a darn. When the...
  • andy-duncan-and-claudio-grassA Looming Banking Crisis – Is a Perfect Storm About to Hit?
      Andy Duncan Interviews Claudio Grass Andy Duncan of FinLingo.com has interviewed our friend Claudio Grass, managing director of Global Gold in Switzerland. Below is a transcript excerpting the main parts of the first section of the interview on the problems in the European banking system and what measures might be taken if push were to come to shove.   Andy Duncan of FinLingo.com (left) and Claudio Grass of Global Gold (right)   Andy Duncan: How do you see the...
  • spankinggoodtimeUS Stock Market - a Spanking May be on its Way
      Iffy Looking Charts The stock market has held up quite well this year in the face of numerous developments that are usually regarded as negative (from declining earnings, to the Brexit, to a US presidential election that leaves a lot to be desired, to put it mildly). Of course, the market is never driven by the news – it is exactly the other way around. It is the market that actually writes the news. It may finally be time for a spanking though.   Time for some old-fashioned...
  • www-usnewsLove him or Hate him: Trump is the Revolution Against the Establishment
      The U.S. Elections: The Latest Crack in the System The 2016 U.S. presidential elections are unprecedented: I don’t believe we have ever witnessed before a campaign year so toxic, so dangerously divisive and full of ad hominem attacks. Both camps have vilified the opposition and their followers, creating a schism in society. There has been no rational dialogue on the issues that truly concern the American public.   The schism Illustration by : M. C....
  • larry-1Meet Your New Stimulus Allocation Czar
      March Towards Midnight The march towards midnight is both stirring and foreboding.  Like a death row inmate sitting down to savor his last meal, a grim excitement greets the reality of impending doom.  Thoughts of imminent mortality haunt each bite.   Tic-toc, tic-toc...   As far as the economy’s concerned, there’s no stopping its march towards midnight.  The witching hour’s rapidly approaching.  We intend to savor each moment and make the best of...
  • state_police_980_600_s_c1_t_c_0_0_1Are the Deep State’s Drones Coming for You?
      What’s Aleppo?   Look out kid Don’t matter what you did Walk on your tip toes Don’t try "No Doz" Better stay away from those That carry around a fire hose Keep a clean nose Watch the plain clothes You don’t need a weather man To know which way the wind blows – “Subterranean Homesick Blues,” Bob Dylan   The entrance to Baghdad's “Green Zone”. Photo credit: Karim Kadim / AP   DELRAY BEACH, Florida – Biggest foreign policy blunder...
  • speculatorInterview with Doug Casey
      Natalie Vein of BFI speaks with Doug Casey   Our friend Natalie Vein recently had the opportunity to conduct an extensive interview with Doug Casey for BFI, the  parent company of Global Gold. Based on his decades-long experience in investing and his many travels, he shares his views on the state of the world economy, his outlook on critical political developments in the US and in Europe, as well as his investment insights and his approach to gold, as part of a viable strategy for...
  • chairman-tienanmen-square-beijingDonald is Right – The System is Rigged
      Scams and Flimflams BALTIMORE – For weeks, the top news headlines have been about politics. And politics has been all about the Republican Party candidate for president of the United States, Donald Trump.   Two very different elections...   The Establishment, the media, and most right-thinking people look around and sniff the air. Something stinks. And the smell, they say, is coming from that skunk, Trump. Meanwhile, Hillary, all greased up with expensive...
  • where-to-goThe Bamboozled Middle Class
      Gassy and Bloated BALTIMORE – What a great time for an observer with a sense of mischief! This year’s presidential campaign is the most absurd and remarkable we have ever witnessed. After more than two centuries, Americans are finally getting the democracy they deserve – one that is grotesque... slimy... and immensely entertaining, albeit in the mud-wrasslin’ genre.   The mud-wrestlers – well, we did promise you in these pages it would be entertaining like never...

Austrian Theory and Investment

Support Acting Man

Own physical gold and silver outside a bank




Realtime Charts


Gold in USD:

[Most Recent Quotes from www.kitco.com]



Gold in EUR:

[Most Recent Quotes from www.kitco.com]



Silver in USD:

[Most Recent Quotes from www.kitco.com]



Platinum in USD:

[Most Recent Quotes from www.kitco.com]



USD - Index:

[Most Recent USD from www.kitco.com]


THE GOLD CARTEL: Government Intervention on Gold, the Mega Bubble in Paper and What This Means for Your Future

Buy Silver Now!
Buy Gold Now!