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2016-12-08 12:52:15
Surge in Dollar Provokes Jitters in Emerging Markets Around World

The election of Donald J. Trump has set off a monthlong run of investor ebullience, whose highlight has been a sustained increase in the value of the dollar against the world’s currencies.

It is a surge that has been embraced on Wall Street as a powerful emblem for a United States economy potentially poised to hit a higher gear thanks to tax cuts, government spending and regulatory relief — policy measures that the president-elect has promised to enact immediately.

But around the globe, the surge in the dollar is provoking financial jitters.

Emerging market countries and corporations that have been binging on cheap dollar debt for more than a decade now face a spike in servicing costs and elevated debt burdens.

And the global financial giants — banks, insurance companies and mutual, pension and sovereign wealth funds — that have financed this $10 trillion borrowing bonanza must confront a period of higher interest rates and tighter financial conditions that will make them less willing to extend credit to companies and investors alike.

“It is the ubiquitous nature of the dollar and its role in the global banking system,” said Hyun Song Shin, the head of research at the Bank of International Settlements, a forum for global central banks. “When the dollar goes up, it directly impairs the risk-taking capacities of banks and investors alike.”

Last month, shortly after Mr. Trump’s victory, Mr. Shin released a paper, circulated widely since, arguing that the new “fear gauge” on Wall Street is the direction of the dollar.

A sharp move up in the currency should be seen as a blinking red warning light for investors, he wrote. When it moves in the other direction, then it is “risk on,” to use trader parlance for when it is time to lay down speculative bets.

Since the election last month, a broad index for the dollar has risen 4 percent. This move, however, masks even sharper increases against a number of currencies.

The dollar has gained 10 percent against the Mexican peso and 8 percent against the Japanese yen.

Against the Chinese yuan, the move has been less pronounced — just 1.5 percent. But Mr. Trump’s combative language toward China has ignited concerns in Beijing that local savers will try to send more of their deposits abroad, putting more downward pressure on the yuan.

The rockiest reaction so far to the dollar’s tear has been in Turkey.

When the Turkish lira fell to its lowest level in decades against the dollar last week, the country’s president, Recep Tayyip Erdogan, took the unusual step of urging Turks to sell the dollars that they had been hoarding and buy their local currency.

With its high levels of debt in dollars and reliance on volatile capital flows for its financing needs, Turkey, more than most of its peers, has been vulnerable to the episodic fits of the emerging markets contagion that have plagued the global economy in recent decades.

Boldly new, as well as contentious, Mr. Shin’s thesis has not been wholly embraced by economists and policy makers.

For example, William C. Dudley, the president of the Federal Reserve Bank of New York, the regulator that keeps the closest eye on incipient financial risks, has made it clear on numerous occasions that the dollar’s recent rise should be seen as a positive sign.

It is not just what a strong dollar says about a growing United States economy, but it is the further prospect that, as a result, Japan and Europe may also emerge from their years of deflationary slough.

“The dollar is firm because people view the U.S. economy as having a better outlook — that is certainly a good thing,” Mr. Dudley said in a recent interview with CNBC. “So that is not something I would be particularly concerned about.”

But as Mr. Shin and his team of economists at the Bank of International Settlements see it, it is not just the threat of the dollar’s rise precipitating a crisis in a dollar-sensitive market like Turkey, South Africa or Brazil that is cause for worry.

His concerns also center on the global banking system and the possibility that the dollar’s rise will accentuate what he refers to as an emerging dearth of dollars, which could bring back memories of the financial crisis in 2008 and 2009, when a global rush into dollars created a liquidity panic.

Short-term borrowing rates skyrocketed, forcing hedge funds to shut down and banks to fail.

“The lessons of the dollar is that everything is connected,” he said. “Spillovers and spill backs can loom large.

One way to observe this phenomenon is to track how much it costs to borrow in dollars for banks that use the yen, euro and Swiss franc.

Since the election, the cost of borrowing dollars short term in all these currencies has risen markedly, with Japan being the outlier.

And in countries like Malaysia, where exporters are hoarding dollars in fear of the currency weakening further, central banks are imposing rules requiring companies to exchange as much as 75 percent of their export earnings into the local currency, the ringgit.

Connections between sustained periods of dollar strength and bouts of financial instability have been drawn by other analysts, like Julian Brigden at Macro 2 Intelligence Partners. In particular, he points to two such periods.

The first is 1979 to 1985, when the dollar rose over 80 percent after Paul A. Volcker, then the chairman of the Federal Reserve, increased interest rates and President Ronald Reagan came to power pushing tax cuts.

During this period, the Latin American debt crisis peaked and the United States’ trade deficit with Japan grew to politically unacceptable levels, prompting what has come to be known as the Plaza Accord — an agreement between the United States, Japan and Europe, the likes of which has not been seen since, to force a weakening of the dollar.

Then there were the years between 1995 to 2002, when currency crises rippled through Southeast Asia and the implosion of the dot-com boom in the United States rocked stock markets.

During such eras of dollar strength, global central banks were forced to dip into their reserves to defend their weakening currencies, leading to what some economists are now calling quantitative tightening.

That would be the flip side of quantitative easing, the policy of the past decade where central banks have flooded the world with cash in a bid to spur growth and combat inflation.

“This is a concern for Fed Chair Yellen,” said Paul Christopher, an investment strategist at Wells Fargo Advisors. “In the type of global economy we live in, she has to be careful about the dollar increasing too much, creating dollar shortages and liquidity problems as a result.”