by Ivan Martchev

April 7, 2020

While a lot of indexes in the commodity and equity space have rebounded – or “dead-cat bounced” off their March lows – one index is refusing to do so. The JP Morgan Emerging Markets Currency Index is making fresh all-time lows. Because it is not widely available to the general public and is somewhat esoteric, an easier way for the average investor to keep an eye on emerging market currencies is via the exchange rates of the Russian ruble or the Brazilian real. Here is their 10-year trend in units per dollar.

Brazilian Real versus Russian Ruble Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

The reason why those two economies are important is that they are in better shape than the other, weaker emerging markets, where the currencies are in even more serious trouble. The Brazilian real closed at an all-time low last week at 5.35 to the U.S. dollar while the Russian ruble is just off its all-time low of 80.

Russia is the most fiscally-conservative of any major emerging market, yet it is also the most leveraged to the price of crude oil, which suffered a record decline of 66.5% in the first quarter. As the price of crude oil goes, so goes the Russian economy and the Russian federal budget, which is typically funded about 50% from oil revenues. To balance that, the Russians have a “rainy day fund” in the National Wealth Fund of $114 billion that they can dip into when they are short on oil revenues.

Brazil Total Gross External Debt versus Brazilian Real Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

As bad off as Russia is with super-low oil prices, Brazil is not in as good shape as Russia. Brazil’s total external debt stood at $672 billion in early 2020 and its debt has more than tripled in 15 years. Since the 2008 financial crisis, the net global borrowing in U.S. dollars has more than doubled to over $12 trillion.

I thought this record total net dollar borrowing would be a problem at a time of Federal Reserve monetary tightening, like we had in 2018. Then, weaker emerging market currencies with insufficient forex reserves – like the Argentine peso and the Turkish lira – got decimated. Now that there is no longer any Fed tightening, the emerging markets currency space is in even worse shape.

What the currency markets are saying is that the collapse in the volume of global trade and the prices of major commodity indexes is a bigger problem than the Federal Reserve for most emerging markets. Rising U.S. interest rates and strong U.S. and global economies are a heck of a lot better deal than rock bottom U.S. interest rates and a global recession, yet both result in a surging dollar because of this massive synthetic global short dollar position.

Why is Borrowing Dollars Equal to a Dollar Short?

An emerging markets government (or a corporate entity, for that matter) takes a lot of U.S. dollar loans, due to years of very low dollar interest rates after the financial crisis, not worrying that those interest rates might someday rise. That entity then exchanges those dollars for its local currency and uses the proceeds as they please. When the emerging market government or corporate entity has to repay the dollar loans, it has to buy those dollars back and sell its local currency. If there is record net global dollar borrowing, that means there is also a record net dollar short position.

Rising U.S. interest rates, like we had in 2018, make it more expensive to service record global dollar borrowings. Collapsing commodity prices and trade volumes have the same effect, as they affect the trade flows for major commodity producers very quickly while the level of dollar borrowings remains high.

Commodities Research Bureau Commodity Index versus Brazilian Real Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Henry Kissinger wrote last week in The Wall Street Journal that the COVID-19 menace has changed the world order (see April 3, 2020 WSJ “The Coronavirus Pandemic Will Forever Alter the World Order”). To that, I might add that it also stopped enforcement on the Phase I U.S./China trade deal and indefinitely postponed the Phase II trade negotiations. The COVID-19 menace will also become a massive political issue in the 2020 Presidential Election, as the U.S. is perceived to be behind the curve in its response.

A good economy is an electoral advantage for the incumbent president and a bad economy is the opposite, even if not his fault. It sure seems that the coronavirus killed more than two birds with a single bug.

All content above represents the opinion of Ivan Martchev of Navellier & Associates, Inc.

Please see important disclosures below.

About The Author

Ivan Martchev
INVESTMENT STRATEGIST

Ivan Martchev is an investment strategist with Navellier.  Previously, Ivan served as editorial director at InvestorPlace Media. Ivan was editor of Louis Rukeyser’s Mutual Funds and associate editor of Personal Finance. Ivan is also co-author of The Silk Road to Riches (Financial Times Press). The book provided analysis of geopolitical issues and investment strategy in natural resources and emerging markets with an emphasis on Asia. The book also correctly predicted the collapse in the U.S. real estate market, the rise of precious metals, and the resulting increased investor interest in emerging markets. Ivan’s commentaries have been published by MSNBC, The Motley Fool, MarketWatch, and others. All content of “Global Mail” represents the opinion of Ivan Martchev

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