There is a lot of dollar denominated debt throughout the world, which poses two problems. Higher interest rates are making it more difficult to service debt, and the dollar has been strong against foreign currencies. From Matthew Piepenburg at goldswitzerland.com:
One can’t emphasize enough how dangerous the current macro setting is in the wake of a deliberately strong and illiquid Dollar.
Biden, of course, says not to worry. We say otherwise.
The Illiquid Dollar: We Showed You So
Over the years, we have written and reported a great deal about the US Dollar and the ironic mix (as well as danger) of its over-creation yet simultaneous lack of liquidity.
This illiquid Dollar, as argued since the first repo crisis of late 2019, combined with a now weaponized US Dollar on the backs of intentionally rising rates by a cornered and Volcker-wannabe Fed, all converge to spell short-term power for the Greenback and longer-term misery for just about every other asset class and economy in a now openly fractured global financial system.
As to the stark reality/risk of this illiquid Dollar, rather than just say “we told you so,” it would be better to “re-show-you so” by making specific reference to a prior report published in December of 2021.
“Dollar Illiquidity—The Ironic Yet Ignored Spark of the Next Crisis”
Since penning that report just over 10 months ago, it’s worth revisiting the implications of an illiquid Dollar and the financial crisis of which we warned then and now find ourselves today.
Investors herd, driving prices up and then scattering, taking their liquidity with them, when the market heads the other way. From Romain Bocher at theswarmblog.com:
Down the Market Hole
While the S&P 500 keeps rallying and hitting new records, the spectacular collapse of Archegos family office brought a sharp reminder of the consequences of excessive leverage in the financial system.
As always, Warren Buffet had already warned us: “Having a large amount of leverage is like driving a car with a dagger on the steering wheel pointed at your heart. If you do that, you will be a better driver. There will be fewer accidents but when they happen, they will be fatal.”
I do not know what the worst part of that story is. Whether it is the fact that Bill Hwang had criminal record. Or that Archegos used the same collateral to enter contracts with up to seven banks boosting leverage as high as 500%. Or if it is Nomura’s reaction, saying basically that whatever happens central banks will rescue banks if needed. Nothing seems to matter anymore for a system accustomed to perpetual bailouts since the LTCM failure.
But beyond those ethical considerations, the Archegos collapse has taught a few interesting things about US capital markets.
The first lesson for investors is the fact that years of lose monetary policy have laid the ground for moral hazard and very risky bets, as evidenced by the record of margin debt. And the higher the leverage ratio, the bigger the vulnerability to unexpected moves.
This is probably a good time for mutual fund investors to think about their mutual funds’ liquidity under stress: can you get out when you want, or is it a roach motel? From Wolf Richter at wolfstreet.com:
“First-Mover Advantage” in a “Liquidity Mismatch”: How slow-poke investors in conservative-sounding mutual funds can get their faces ripped off.
When it comes to conservative-sounding open-end mutual funds, particularly those invested in bonds, loans, thinly traded stocks, real estate, and the like, “first-mover advantage” means: When there are signs of trouble, get out early. Because if you don’t, you can get your face ripped off.
“First Mover Advantage” is known, which is part of the problem.
Astute fund investors know about the first-mover advantage. So they keep an eye on the markets, and when they see stress in the asset class that the open-end mutual fund is invested in, they pay close attention. And when the first warning signs appear in the fund itself, they get out of the fund. “Open-end” mutual funds are those where investors can on a daily basis buy shares from, or sell shares to the fund sponsor to get into or out of the fund.
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Why you’re better off owning high-quality individual bonds rather than bond funds or ETFs when the bond market is going to hell. From Wolf Richter at wolfstreet.com:
Bond ETFs and open-end bond mutual funds sound conservative in marketing materials, but they pack special risks & surprises in a downturn that can entail a catastrophic loss for investors.
Exchange-traded bond funds and bond mutual funds are big business. They’re a lot easier for retail investors to buy and sell than the actual bonds, particularly bond ETFs, which trade on stock markets just like stocks — and can even be day-traded. But this liquidity for investors is precisely the potentially catastrophic problem.
And in this era of rising interest rates and deteriorating credit, bonds already have plenty of other problems.
Corporate America carries record amounts of debt. Part of this debt is in form of bonds (the other part is in form of loans). The amount of bonds outstanding has ballooned over the past five years, even as the credit quality has deteriorated. Now there are $6.1 trillion of investment-grade US-corporate bonds outstanding, according to Moody’s (plus over $1.2 trillion of “junk bonds”). These bonds are everywhere, including in bond ETFs and bond mutual funds, and therefore in retail investors’ portfolios.
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