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Emerging Issues with Emerging Market Debt

By LINDON, Utah - July 9, 2018 No Comments

Everyone wants to get their money back into the USA now that interest rates are up, so emerging market debt default risk is rising. It is an old story with a new twist. This time actually is different. The emerging markets have grown so large that debt defaults there are much more likely to spread to the rest of the financial system.

The most immediate danger comes from dollar-denominated debt. Many emerging market governments have histories of devaluation and inflation, so international investors are unwilling to lend to them in their own currencies. About 70% of this external debt is in US dollars, and Americans have rushed in as ETF holdings of external debt doubled between 2016 and 2018. Foreign countries that borrow in US dollars must deal with plunging currencies and rising rates at the same time, so they are usually the first dominoes to fall.

In any crisis, there are "canaries in the coal mine" that warn investors of approaching disaster. Turkey and Argentina are under the most pressure. Turkey's external debt is equal to more than half the nation's GDP, and the Turkish lira is down more than 15% against the US dollar this year. The Argentine peso hit multiple record lows against the dollar in 2018 as the government burned through over 5 billion dollars trying to defend their currency. Now, Argentina is looking for more money from the IMF.

It is important to realize that the early stage of a crisis is the best time to seek shelter. Don't assume that you are safe just because you don't directly hold any emerging market debt. If we learned anything from 2008, it was that defaults spread quickly because all the big banks owe money to each other. Precious metals provide the only sure protection from debt defaults. Gold and silver are still relatively inexpensive today because the greatest dangers still lurk beneath the surface.

The three largest banks in the world are all located in China, and China is awash in corporate and consumer debt. China's corporate debt stood at 168% of the country's GDP in 2017, and China's total debt was close to 33 trillion dollars. The inevitable unwinding of the debt-fueled bubble in China could prove disastrous. In a world where we have gotten used to "too big to fail" arguments, China is too big to save.

It's easy to ignore the issues with emerging market debt because we've all been through this so many times before. Hyperinflation, debt defaults, and crisis seem to be normal in much of the world. We are used to being the happy exception here in America, but the world is changing. China's big banks have made their way into the American economy, so emerging market debt affects nearly everyone now. In a world of vanishing safe havens, precious metals are the last best hedge against emerging market debt defaults.