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The Fed's Global Dollar Problem

Mark Whitehouse writes editorials on global economics and finance for Bloomberg View. He covered economics for the Wall Street Journal and served as deputy bureau chief in London. He was previously the founding managing editor of Vedomosti, a Russian-language business daily.
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The Federal Reserve might be doing the right thing for the U.S. economy by moving to bring interest rates back up to normal. But for foreign companies and governments that have borrowed trillions of U.S. dollars, the adjustment could be painful.

Thanks in large part to a prolonged period of extremely low U.S. interest rates, borrowers around the world have gone on a dollar binge over much of the past decade -- making them more vulnerable to the Fed's policy decisions than ever before. As of September, non-bank companies and governments outside the U.S. had some $10.5 trillion in dollar-denominated debt outstanding, according to the Bank for International Settlements. That's more than triple the level of September 2004, the last time the Fed was about this far into a cycle of rate increases. Here's a chart:

Borrowing in Dollars
 
Source: Bank for International Settlements

If the Fed sticks with its plan of raising rates more than a percentage point by the end of next year, the increased interest costs could stunt growth and weigh on borrowers' finances in places as far flung as the U.K. and China. It could also mean losses for investors holding the debt, particularly given that the duration of dollar-denominated bonds -- a measure of their price sensitivity to changes in interest rates -- is close to its highest point in at least two decades. An increase of one percentage point, for example, would take $500 billion off the value of the bonds included in the Bank of America Merrill Lynch U.S. Dollar Global Corporate and High Yield Index. Here's a chart showing how that number has changed over the years (thanks to a combination of increased dollar debt and increased duration):

Dollars at Risk
 
Source: Bloomberg, Bank of America Merrill Lynch
*On bonds included in the Bank of America Merrill Lynch U.S. Dollar Global Corporate and High Yield Index

The broader effect of such losses will depend to a large extent on where the risks are concentrated. If they're spread out among a lot of investors with solid finances, it could be no big deal. If they're focused on thinly capitalized banks, it could be more damaging. In any case, the repercussions will likely come back and hit markets and growth in the U.S. as well. Which means that the Fed will have to keep all that dollar debt in mind as it decides what to do.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Mark Whitehouse at mwhitehouse1@bloomberg.net

To contact the editor responsible for this story:
Stacey Shick at sshick@bloomberg.net