The $10 Trillion Problem behind the Trade War

The $10 Trillion Problem behind the Trade War

I read a book a few years ago called Confessions of an Economic Hitman.

The author, John Perkins, claims it was a recount of his time working for an engineering consulting firm in the US.

His role was simple. Perkins would fly out to underdeveloped countries and convince their leaders to build massive infrastructure projects.

Perkins would sell them loans; these contracts went to some of the richest families in the US.

But here’s the catch…

Perkins only went to poor countries rich in natural resources. And there’s a specific reason for this.

As Perkins says, all the loans that were written were never meant to be paid back.

When these countries realised they could never pay back the loans, they had two options: default and ruin their credit rating…or barter their resources in exchange to offset the debt.

In other words, these nations were desperate to ‘upgrade’ their underdeveloped economic standing. They made deals with rich lenders, hocking themselves up to the eyeballs in debt…only to discover that they were hostages to the US dollar denominated loans.

And now a similar situation is unfolding…

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Look at this chart, which shows the incredible amount of debt floating throughout the financial system:

Emerging Market Debt 1990–2017

Source: The Daily Shot

Analysts spend a lot of time discussing federal government debt.

But what about smaller, private corporate bond issuance?

While US dollar denominated government bonds (light blue) has grown since 2014, it isn’t the real problem.

The ignored danger in this chart is the corporate bond issuance of US dollar-denominated debt (dark blue).

It’s risen significantly since the financial crisis ended in 2009. And now accounts for more than 50% of total emerging market debt, up around 25% from a decade earlier.

This chart shows the debt issued yearly…not the total amount outstanding.

In other words, half a trillion dollars in US debt is given to emerging markets, adding to the already high levels of emerging market debt.

A conservative estimate suggests US dollar-denominated debt in emerging markets is around US$3 trillion. However, in a recent interview with Jim Rickards, he told me this figure is much more likely to be US$10 trillion.

The debt isn’t evenly spread throughout the financial system either.

Unsurprisingly, the US dollar-denominated loans are concentrated to a few key players.

China is tipped to hold about 30% of US dollar-denominated debt, with Brazil, Russia and Mexico making up a collective 25%.

Furthermore, research from the Reserve Bank of Australia noted in 2015 that the debt issued by US corporations was largely concentrated to certain industries: real estate and construction and oil & gas.

Of course, trillions of dollars in debt isn’t an issue when markets are booming. When the debt falls due, it’s simply rolled over, and the debt cycle begins again.

The problem with all this US dollar-denominated debt is that it was issued in a financial system desperate to get back to normal after the panic in 2008.

Back then, US President Obama desperately wanted to maintain a globalist policy. The US was able to lend out all the money it wanted with the Federal Reserve Bank keeping interest rates near zero for a decade.

Money was cheap, and the US lending machine was keen to get going once more.

That was then. What we have now is a financial system with trillions of dollars of US dollar-denominated debt sleeping in the financial system.

The reality many emerging markets are facing is that US President Donald Trump is out to stifle trade through tariffs.

On top of that, the Fed is in the middle of raising interest rates from near zero to a projected base rate of 3–3.5% by 2020.

These digital zeroes in the form of corporate bonds will need to be paid back eventually.

Rising interest rates from the Fed will make those loans more expensive.

And Trump targeting China will eventually slow their economy down.

Anything that slows growth reduces the money coming in. And if less money comes in, those increasingly expensive interest rate payments suddenly become harder to meet.

Trump might think he’s starting a trade war.

In reality, he’s just making this US$10 trillion debt harder to repay.

Kind regards,

Shae Russell Signature

Shae Russell,
Editor, The Daily Reckoning Australia