The same conditions prevailed in the 20th century, with the dollar succeeding the pound as a monetary lingua franca. In the 1970s, for example, high inflation, a weak dollar and growing quantities of dollar-denominated debt set countries like Mexico up for disaster.
It happened after US Federal Reserve Chair Paul Volcker began ratcheting up interest rates to control runaway inflation. Between the middle of 1980 and early 1985, the dollar’s value relative to other currencies soared by 77 percent. Mexico and other countries became casualties as the cost of servicing their debt became unsustainable.
This pattern has repeated itself in subsequent episodes. Mexico sustained another foreign-debt crisis in 1994, as did a number of Asian countries in 1997, Russia in 1998 and Argentina in 2002. Then the dollar began a period of general decline for nearly two decades, during which the sole serious financial crisis was unrelated to the wages of original sin.
Moreover, though dollar-denominated sovereign debt remains common, it doesn’t play quite as significant a role in financial markets as it once did: some developing countries have managed to issue debt in their own currencies. This might suggest that we won’t see a replay. But that provides them only limited protection. Many corporations in those regions cannot arrange for financing via long-maturity, fixed-rate loans denominated in local currencies. Instead, they go abroad for financing, often borrowing in dollars. This is “domestic” original sin, but sin nonetheless.
The scale of this borrowing has grown significantly since 2007, when it amounted to less than 10% of the world’s gross domestic product. It’s now in excess of $12 trillion, or 14% of global GDP, and rising. That worked well so long as the dollar remained in the doldrums. But that’s not the case any longer.
Perhaps the Fed will decide that an emerging-market meltdown is too high a price to pay for taming inflation. But if Fed Chair Jerome Powell pulls a Volcker and the dollar continues to strengthen, emerging economies will be reminded, yet again, that they live in a fallen world.
This article was provided by Bloomberg News.