Pay It Forward

In yesterday’s blog (Unclear and Present Danger) we raised the prospect that America is being asked to boost its contributions to the International Monetary Fund (IMF).  Why would Christine Lagarde, the current Managing Director of that organization, feel the need for additional funds from us and other developed nations?

Ever since the world’s major central banks have dropped interest rates down almost to zero, financial institutions have been looking for places to invest that paid better than what was available stateside.  In response, banks and shadow banks alike have been lending to emerging market companies.  Many of the loans were done via offshore subsidiaries in places like the Cayman Islands that provided better tax treatment on the returns, sometimes allowing loans (bonds) to be provided to firms in countries where asset managers could not otherwise do business.

And the point?  Turns out these companies often denominated these bonds in dollars, taking the funds received and converting them into their own county’s currency in order to use them at home.  This exchange must be reversed when repayments are made.   Lately, such firms are finding it more difficult to pay off the loans because the U.S. currency has been strengthening relative to their own.  This makes it more expensive to service the debt, thus eating into profitability and decelerating output.

Furthermore, banks and shadow banks may begin to sell their holdings of these loans and/or make fewer loans available.  It is unclear how devastating this sequence may be to various countries because the total amount of the outstanding loans is not fully understood.  Since many of the transactions occur offshore, they do not get counted in official statistics.  Estimates from the Bank of International Settlements (BIS) suggest there are nearly twice as many of these bonds outstanding as the standard count demonstrates.  For example, the BIS estimates Russian firms are on the hook for $115 billion when standard count indicates the amount owed is only $42 billion.  Oh yeah, Chinese real-estate firms have been some of the most prolific borrowers, and many recent anecdotes from this nation’s economy have not sounded positive.

If, for any number of reasons, too many sellers of this paper suddenly emerge, liquidity could dry up in a heartbeat and lead to a freezing of global finance much like we saw back in 2008.  Should such circumstances develop, a run on some emerging market companies could have dire consequences.  To lower the odds of this occurring, the International Monetary Fund (IMF) wants to fatten their purse by asking developed nations to pony up more funds.  According to the Wall Street Journal, the IMF currently has around $1.4 Trillion available for such bailouts and would like to see us provide an additional $64 billion above our current quota.  The problem is, our Congress, led by strong Republican resistance, has, since 2010, blocked any attempt to raise the amount we donate.  With the latest election strengthening their hand, Atlas sees little chance new funds will be forthcoming anytime soon.  The needed push for resolution of this situation may once again come down to brinksmanship, not leadership.        (by C. Cox and J R)