The Beginning of the End

Cycle up, cycle down.
Bigger than Greece, bigger than China (or at least one of the most significant parts of the China story) is the massive shift occurring in global currency reserves. Long story short: they’re being depleted, rapidly. Especially the reserves of emerging market sovereigns.

In a highly unusual development, emerging-market FX reserves have been falling steadily since the middle of last year. The IMF’s COFER figures, the gold standard for FX reserve data, show that emerging-market reserves have dropped for three successive quarters, from a peak of USD 8.06trn at end Q2 2014 to USD 7.5trn by end Q1 2015. COFER data are not yet available for Q2, but we have been able to build an estimate from already released second-quarter national data. Our bottom-up estimate of around USD 6.9trn at the end of Q1 captures 92% of the IMF’s emerging-market aggregate. By our estimates, emerging-market reserves continued to fall in Q2, albeit marginally, by USD 21bn or so.

Q2’s modest fall brings the drop-off in emerging-market reserves to USD 575bn since the middle of last year. Looking at a longer run of COFER data from 1995 shows how unusual recent developments are. Even in the jaws of the global financial crisis, emerging-market reserves only dropped for two quarters before snapping back vigorously. Emerging-market reserves have not fallen on such a sustained basis in at least 20 years (Chart 2).
Most dollar bears thought the greenback would die first and die alone, maybe with a few other developed countries, but they ignored the credit bubbles and debt accumulated in China and other emerging markets. The last days of the dollar are unfolding, but the emerging market exit from the U.S. dollar system will not be voluntary or planned. Countries will sell off their dollar reserves amid a great U.S. dollar bull market attempting to prevent currency collapses at home. At the end of this phase, collapse or not, they will own very few U.S. dollars and the greenback will be extremely overvalued. The U.S. debt market will be a lonely giant as much of the world's debt markets go up in smoke due to currency devaluation. Then it will be America's turn.

FT: The greatest sustained EM reserve slump in 20 years

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