This week we examine how dollar strength is intertwined with pain for developing nations. Sri Lanka is serving as a warning to investors with nearly two dozen countries currently staring at default. Europe, too, faces tough choices as Russia closes the energy spigots. We speak with Liam Denning, Ruth Pollard and Stephen Mihm.
This is Bloomberg opinion. I'm Vonnie Quinn. This week people say that this is the worst crisis President nature from the British Ruth Pollard on tri Lanka's warning to the world, and later Stephen mim on the stronger dollar's role in hurting developing nations. First related to the global pain, oil paid for, of course in dollars. Let's get to Liam denning. Liam, oil prices have come down over the last few weeks. How has that affected supply and demand? Well, I think it's a reflection of anticipation of supply and demand. So you know, the run up we saw in the say, first and second quarter of the year was really explicitly linked to the disruption of Russia's invasion of Ukraine and fears of what that might mean for supply. As sanctions began to ramp up, as some buyers of Russian crew began to draw back voluntarily for fear of reputational or regulatory clash. There's an old saying in the industry which is that the cure for high are prices is higher prices. So quite quickly we saw this alternative narrative begin to come into the market, which is you know, the economy is just recovering from COVID, the global economy, and it's still suffering the effects of that recurrent shutdowns in China and that sort of thing. So people began to worry, well, we're seeing these high prices. Now everyone's panicking, But what if this all tips into a recession next year? And I think those are the two competing narratives we're seeing. I think the reality is that expectations of disruption to Russian oil supply were probably a bit overplayed at the beginning. People were talking about, you know, two to three million barrels of Russian supply immediately getting knocked off the market. Some has been, but nowhere near that figure. You know, the Russians have found ways to sell the oil at a discount. In the meantime, we are definitely seeing pressure on the European economy from all sorts of Ukraine related pressures, notably around what's going to happen with natural gas, and we are starting to see signs of American drivers, still the single biggest pool of oil demand on the planet, starting to maybe take notice of those high gasoline prices that we've seen, even though they have been coming down I actually saw a board dollar or something at the MOMP the other day. Yeah, so, so you know, they went above five bucks for the first time ever in June. I believe it was, and that does appear to have had an effect in the context of broader inflationary pressure exactly. Now. Open Plus meets Wednesday, and it of course includes Russia. Will Russia counter calls for a more Persian crewed I think they will do so probably in the background Plus in some ways is in a strong position, right. You know, all prices are high, everyone's worried about tight supply. We haven't seen US shale raw back as it might have done a few years ago because of the constraints placed on it by investors. On the other hand, it's also in a difficult position. The likes of Saudi Arabia and the UAE, the big players in Open Plus, certainly don't want to tip the global economy into a recession that doesn't do them any good. As much as they are trying to deal with what they see as a United States that is pulling back from the Middle East, they also face a reality that they still depend overwhelmingly on the United States for their defense, for weapons, sales, for the presence of the fleet, for defending shipping lanes, etcetera, etcetera. So they are playing this balancing act of trying to keep Russia within OPEC and not the place exactly, and they had to at the time because they had kind of lost their position of influencing prices. So they're trying to keep Russia on board and not be seen to, for example, direct lots of oil towards Europe to help it out. At the same time, they don't want to completely break with the US, you know, and don't forget. Will that have made a difference. It didn't seem to at the time. They were keeping their options open and felt like, I actually think it's hard to say, you know. I think that the broad reaction was that it was kind of a mayor tour, like nothing happened. I think, frankly, it's too early to say, you know. I think Biden's aim was a couple of things. One was to essentially get over this issue he has had with the Crown Prince of Saudi Arabia, his whole call to make him a prior on the campaign trail without completely being seen to get down on his knees and at the same time affirm that the US was still a presence in the Middle East. We won't really know how much of an effect that's had for a while because it will come through actions. You know, what will Biden do the next time a missile gets lobbed in from Yemen? What will he do with the next call for for an arms sale. It's it's hard to say. I want to talk to you a little bit about natural gas in Europe as well. There's a relationship there between the two obviously, but natural gas is trading sort of ten times higher than it was ten times. I mean, that's a huge increase and there's almost no supply where capacity now, and there is a fear that Russia will cut it to zero, which is very possibly. Could this's what one turbine working or something. Yeah, I mean I think working with quotation marks. We saw them do this actually with the deliveries from the Caspian pipeline not too long ago, where you know, a documentation issue was was getting in the way. I think. Look, the way to think about this is Europe is very dependent on Russian gas, you know, Russian gas imports. I think last year was something like of western Europe's gas consumption. You can't do without that. The Russians quite coincidentally and down their gas storage in Europe last four which was actually when we began to see these price increases come in, way before the acts of Ukraine. And I think the way President Vladimir Putin of Russia looks at this is there was this view at the beginning of the war that well, Russia would be crazy to turn off the gas supply to Europe because you know, it's a big source of revenue. Putin has invested billions upon billions in revitalizing the old Soviet legacy gas supply system to Europe, So why would he throw that away? Well, it looks like he has already thrown it away immunition, right, But regardless of what happens with this war and what happens after, the energy relationship between Russia and Western Europe is fundamentally broken. At this point. Pewton knows that he's crossed that rubicon already. So now what is he interested in? Well, what he's interested in is winning this war that he expected to last may be two hours, clearly didn't. And now he's locked in this grinding battle against Ukraine. And by extension, the West, because it's the West that's supplying the weapons that Ukraine is using. And I think from Pewton's point of view, Russia is suffering. Its economy is suffering as much as people point to, you know, a strong ruble and that sort of thing. Over time, the lack of access to technology, the brain drain of people leaving, the effective dismantling of parts of the Russian gas system over time, that's all going to really hurt the economy. This year, the I m F is predicting Russia will have its deepest recession since the early nineties, which is the post Soviet chaos. However, will put and be voted out of office? Not very likely. He looks at the West. He sees, you know, several governments having already fallen, recently, Italy, the UK Prime ministers, parliamentary loss as parliamentary majority, Democrats struggling with high gasoline prices as they head to the mid terms, and he thinks to himself, if I can just push on enough pain points economically, I can get these people to back off. And he may be right about that. You know, one of the things I've noticed about the European Union's response to this is rhetorically, at least, they're not really admitting what the issue is. And the issue is Europe is already in an energy war with Russia. That's how Russia sees it. Europe is still talking of this as essentially an economic problem, you know, it's inflationary, or it's going to cause cost of living increases and hardship and that sort of thing. No, it may have a significant chunk of its energy supplies simply cut off, with implications that can range from high prices, through two factories being shut down, people being thrown out of work, all the way through effects to the labor economy in every and if you have a severe winter, all the way through to people being forced to us between paying their gas bill or paying for food, or literally freezing in their homes. This is a more existential threat than just some high gas prices, and what it demands is a war economy. And what I found interesting about, you know, the agreement that was reached this week for the EU to have this mechanism to cut gas in mind by you know, Hungary's Victor Auburn actually denounced it on Facebook as a step towards a war economy, and you know, we can leave all bands politics aside. But what I found amusing is yes, that's exactly what it is, and that's exactly what Europe needs. It needs to think of this as a war and measures like rationing and planning and coordinating the gas policy to deal with the war situation. So what happens next? Then? At what point do leaders stop denying what's happening and trying to deal with this? And I guess Germany is the obvious example. Do we see mandates bigger mandates? Doesn't seem like asking people to cut their usage by for some time is going to do much. I would look at it slightly differently, and that I think agreements like that are a step towards grappling with the reality of the situation. I think you can, In fact, I think you've seen signs of it in different places. You know, for example, here in the US, we've seen President Biden invoke the Defense Production Act, not necessarily for oil or gas, but he did it for critical minerals for batteries, and that's quite a far reaching Paris and emergency. We've seen him spr use the SPR exactly to adjust the taxes on gasoline prices. I think we're going to see this kind of action. Well, I'd say there's two parts. We're going to see this kind of action happen, particularly as we get closer to winter, and particularly if Pewton decides, well, if the Europeans want to get off Russian gas, there's no way I'm going to wait around and help them do that. I'll just cut it off because as much as he'll take some fine actual hit, oil is really the mainstay of Russian revenue. The gas is really much more a geopolitical tool. So he will be quite willing to cut it off, I believe. And as that reality sinks in, European leaders in particular are going to be faced with a choice. Are they going to back up the rhetoric that they've been talking about with regards to Ukraine, of defending values, of defending European security and therefore adopt more kind of coordinated planned war economy measures whatever you want to call it on the energy side, or are they going to back down. Well, and they need to be voted into office to right, so they're thinking of their own domestic elections, And I mean, is it a case of once people are back in parleman Macon has Obviously he won't have a legislative majority, but he's back in power. I mean, has he got more leeway now than say, some of the other economies where there may not even be a government. I think this is part of the problem Europe has that Pewton tries to exploit. And we saw it, for example, in this the wrangling o you saw particularly Southern European countries say well, we kept our house in order and Germany didn't, so why should we have and obviously back for the euro exactly now we laugh about this, but that is exactly a sort of division that Peutin seeks to exploit. Clearly, some economies are much more exposed, Germany being the prime example. It's very difficult to say how this will play out, because you can say, under one scenario, we have a freezing winter, there's a deep procession in parts of more Than and southern Europe, maybe people literally freezing to death in their homes, and a lot of people just say why are we doing this Ukraine. On the other hand, it's possible that Peutin overplays his hand, does something pretty terrible like that, and that actually leads to people saying this is untenable and as bad as this situation is, we simply can't tie ourselves to a situation where you do what Russia says. At the same time, it's much easier as a citizen of a country to say that when you have your air conditioning or you have your heating, because that's what decisions depend upon, right, the electorate's mood, and it's not going to be very good if they're freezing, and that's absolutely what Putin will count on. I mean, the counterpoint I would say is, I think there are two things that are quite obvious to a lot of voters in Europe. One is Putin's invasion of Ukraine is wholly unjustified, awful. We've seen all the images, We're probably going to see a lot more over time. The second thing is it's quite obvious that the gas isn't flowing because Russia has turned it off. So if any sort of political support is to be built for seeing this through, it will have to rely on reinforcing those messages over and over again. But no question, this is going to be an extraordinarily hard winter for Europe. It's simply tied to literally via a pipeline. A country that effectively sees the worst as its enemy, and it's come to the fore now, Liam Denning there, do get in touch via Twitter a Vanney Quinn or email v Quinn at Bloomberg dot net opinions and comments. Always welcome to Sri Lanka now and Ruth Pollard. So, Ruth, Sri Lanka is in default, inflation is above seventy. We saw protesters sacked the presidential palace the flight of then President got A Biraja Paxa, who later resigned. Now the former Prime Minister of Ranil Wickramasinger has the presidency. He was voted into the presidency. Why did lawmakers vote him in? In particular, I think when Neil is seen by lawmakers as a known quantity. He's pretty well respected on the global stage, having the Prime minister six different times over the past couple of decades, and he's seen as I guess, the safe pair of hands to leave the negotiations with the International Monetary Fund for a much needed bail out package for Sri Lanka. He's got a lot of support from got A Buya Rudget Parks's ruling party in order to take power. So that's really important to bear in mind, right, and he had promised a type of unity government, and yet of the eighteen cabinet ministers that he can appoint, they all seem to be from his party, with the exception of perhaps two from one opposition party. That's not what the protesters were looking for, is it not at all? And indeed Renal is seen as part of the problem by the protesters. He has been been from the political elite and therefore a really big part of what led Sri Lanka to this really really dire situation that it finds itself in now. The protests obviously they were calling for the resignation. That's got a buyout past there, and they complained some victory over having forced him from office and indeed forced him to flee the country. But Renal will have to find some layers really differentiating himself from the rudget parks a government. And one way that he could do that is to acceed to the protests of demands she really cut back on the extraordinary powers of the presidency that got to buyer awarded himself during his short term in office. It remains to be seen whether he will do that. I guess for him the priority is talks with the i m F. Sri Lanka does have a big social safety net, but that hasn't helped. People are suffering and they're angry. That's right. I mean he has two priorities. I think one of them is obviously pushing ahead with these talks with the i MS as well as at the same time speaking assistance from Bile. Actual vendors like Japan, India and China today have been sort of sitting on the sidelines and waiting to see what happens before they come up with any kind of cold hard cash. India has provided a lot of aid in terms of delaying loan payment and sending fuel and wheat and essential medicine to Sri Lanka, but what it really means is cold hard cash to keep the economy you're going. The other priority for Vicumous is to keep the protests at say, while he tries to stabilize the country. Now, he did that to some extent by this violence overthrow the protests as camp out by the presidential residents last week, and obviously that move was widely con then but if he does wind back the powers of the presidency and show some good will towards the protests, then that will go a long way to maintain his stability in the country. China's role, what will it be? President ji Jinping has promised aid, but in fact Belton Road Initiative spending has volunto zero. What are China's intentions? It's very difficult to see what China's plan is. Could Sri Lanka beyond not getting caught up in the slow car crash that we've seen Sri Lanka going through in terms of its default and the political instability that has come after it. China has invested a lot instrumenta over the years as part of its Belton Road program, but that only makes us tempt sense of subject that Sri Lanka owns. So we have to put China's role in in very clear context. Now, a lot of the projects that China has funded as widely seen as white elements, when many of them are flustered in the Rugi pasta heart Landers hand. Then TOTA investors had been looking to Sri Lanka as an example of an emerging market economy that might default and now has defaulted. What kind of an example is this for investors in terms of other developing countries? That might default, given that all the particulars are so individual. In this case, Sri Lanka is very much seen as a warning in the South Asia region. Of course, we're all watching Pakistan and with great interest. It too has uncustainable levels of foreign debt that had just managed to negotiate a deal with the IMF that may be stabilized somewhat. Of course, it is deeply reliant on by election vendors such as Staudi Arabia and China to back in that I MS loan and create even more stability. But it is in a very difficult financial situation and it's certainly not out of the woods yet. Rules you've seen this before. Is this the worst crisis that Sri Lanka has seen? It's obviously been through very many of them. Yeah, I mean obviously discivil war which went for decades was a terrible crisis that the country faced. But when I was in Sri Lanka last week, people from one information to the other said to me that this is truly the worst crisis. They have never had a situation where they've had to queue for fuels, the days and days and days where they've had no access to potential medicines and where people have been taking blood pressure medications, for example, every other day in order to conserve those pharmaceutical where schools haven't been able to operate. Exams can't be done because there's no money to print them on paper. And of course there's a food crisis. Farmers have not been able to harvest crops for sometimes two seasons now, and they're not even sure if they can plant next season's crops because there's no money to import fertilizns. So people say the West Class expressage for nightcract beside from the British Ruth Pollary with us from New Delhi. By the way, do get in touch. Comments and opinions always welcome at Bonney Quinn on Twitter or email v Quinn at Bloomberg dot net. Happy to have Stephen mim with US Now columnist and University of Georgia history professor. We're going to talk about how the strength of the US dollar has been a constant threat to developing nations. Stephen, the Dollar Index d x Y was below ninety for the first half of last year for context. Right now we're above one oh seven, and we've had a little reprieve this month, but we've been essentially strengthening all that time explained to us why this is so significant for other economies. It's very significant because every time the dollar strengthened, there's concurrent weakening of other currencies, and it's not just the Euro. The currencies that are hit the worst and that have the greatest impact are the currency issue by so called emerging economies in Asia, Latin America, Africa, elsewhere the world, and this weakening is something that poses some dangers for these eCos. We know that already Sri Lanka and Russia are in default, both for idiosyncratic reasons, but also at least in Sri Lanka's case, partially because the US dollar is so strong. We're looking at another couple of dozen countries daring default in the face. How much relief would we need to see on d X Y in order for these economies to actually feel some relief, well, a significant amount, which is highly unlikely at this point. I'm afraid because there are all sorts of signals being given by the sort of reserve that they will be serious about finding inflation, and that the war against inflation, particularly at this moment of global chaos, is one that will inevitably lead to the strengthening the dollar. And the key here, of course, is that the strengthening of dollar means that the death of these emerging economies will start to rise the burden of those debts because they're denominated in dollars more often than not. And this is where we get the idea of original sin explained to us. What economists have deemed original sin. Obviously not in the theological sense, right right, But you know, economists are oftentimes blamed for being not very creative. But Barry I. Can Green, who's one of the economistic question who coined this phrase, have to be credited for coming up with a creative way of understanding or framing the question of why is it that many countries around the world are not permitted or unable to borrow in their own domestically issue currencies. Instead, they're forced to borrow in other countries currencies, namely, more often than not, dollars. And he called this phenomenon original sin because when you look at a country like Argentina, for example, but it is a serial defaulter, we often assume that the problem here lies with the institutions of Argentina or other other failings of the tree question the emerging marketing question, and what I can green argued instead is that before any of this became a problem, these countries began borrowing in other countries current and that created the conditions for default. Because when you borrow, especially sovereign debt and in other country's currencies, your hostage effectively to exchange refluctuation, and that also ties your hands in your own fiscal and monetary policy that you can leverage in a time of crisis. So original Senior is kind of the idea that this act of borrowing in a foreign currency pre dates all the other profligacy that we associate with emerging market And it's interesting because when we think of the major crises of our time, we obviously think of big stock market crashes or the Great Financial Crisis, but also the currency crisis. They have been some of the biggest events in my lifetime. You point out in your column this actually goes back two years. Of course, that's right, and it's and going on. You know, it's been a problem, especially in Latin America since really the early nineteenth century, where you know, these these countries borrowed and in not in dollars at that time, they were borrowing in pounds, sterling or in gold to repay debts in gold, but it was effectively the same thing that put them in the cross areas of an exchange rate crisis, currency crisis. And and yes, this this recurrent problem very different from the two thousand seven crisis, but this recurrent problem is one that dominated the existence for emerging markets for close to two years. Stephen. Do you see conditions in place right now for a significant dollar related event or group of events around the world. Yes, I do. That's not to say it will be guaranteed to happen, but the FED is in this extraordinarily difficult position where it can't really go easy on inflation if it to maintain credibility. So if it does continue along those lines, you may see something very similar to what happened back in beginning in early nineteen or mid night when Paul Vulker made it very clear to financial markets that he was he was going to tame inflation. It but the collateral damage of that was, for example, in Mexico being plunged into the ABYSS not long afterward, and in other countries following. Students of subsequent periods, so we've been down this road before, unfortunately, and while it's great for the dollar and great for the credibility of the United States, not so great for emerging markets. No, and in fact, we haven't seen one for quite some time. You point out there in Mexico that was four. There was obviously the Asian currency crisis, Russia, Argentina two two. Have we had one since two thousand two? No, but that's exactly when the dollar began at twenty year decline. I mean not it wasn't a linear decline, but it was a secular decline over those twenty years. And so the dollars suddenly strike thing, you know, reminds us that eventually things always come full circle. And it looks likely, especially if you consider the geopolitical you know, chaos or disorder between Ukraine and all sorts of things happening, it's quite likely that the dollar might strengthen even further. Stephen, What institutions have had success in cleaning up the mess that a strong dollar has created from time to time? Obviously the World Bank and the I m F have had roles. Have they played their part well? Well? At what cost? I think is often the question to clean up? That is often rhymes imposed on these countries so called emerging economies, are oftentimes punitive to an extreme. And while that may be justified in terms of rectifying that, the imbalances, again, the problems predate the act of of of the default that they go back to this this larger issue of original sin. And sadly, you know, these are reminders constantly for folks living in countries like our Continua that they live in a fallen world, that they live in this kind of cycle of what economists are called sin. Well, and you see these ridiculous amounts of inflation in these countries as well. So you have a humanitarian crisis on top of a fiscal crisis, and it spreads you know, social unrest and so on. What's the alternative, I mean, is there an alternative for these countries to having so much dollar denominated debt? Yes, well, one is, you know, a kind of attempt to market debt in their own currency, which, believe it or not, has actually happened to some extent in the last ten years. That well, less since two thousand and seven, there's been more debt denominated in local currencies as we call them. The problem, though, is that while that's happened to some extent, it's gone him and him with a rather alarming development, which is the rise of what's sometimes called domestic original sin, which is a slightly different flavor of of borrowing and currencies abroad. So instead of the sovereign debt being denominated dollars, the corporate non financial and you know firms in say Argentina are borrowing in dollars at law maturities, and so it's the exact same dynamic, it's just different players becoming indebted. So Stephen, having looked at the history of this, usually doesn't end well at least for somebody, and there's usually a winner on the other side as well, typically an individual or a hedge fund, right right, that's right, That's that's absolutely right. There's the these are these are great opportunities for for short to flock in name. I would say, you know, as this as a as an aside that not just because you borrow in a currency than your own does not automatically doom you. There there are clearly many examples and and and one of them is in fact the United States. Originally but you know, it's debt was denominated in gold clauses in other words, that we had to repay our debt in gold, not in dollars, and we were able to quote ungle graduate from that state. But it's something that only seems to happen for countries that achieved some kind of hegemonic status within the larger international financial system, and we're we're one of those countries. Actors. Yeah, John Yellen used to talk about feedback loops. I mean, what will the consequences be for the United States of one or several countries defaulting. Well, I guess I think there's a there's a question here if you look historically and what happens when this happens, like Sri Lanka for example, this kind of canary in the coal mine. The problem that we've seen in the past is that there's then a flight to safety globally. In other words, countries that are completely beyond reproach but that nonetheless are borrowing in dollars are subjected to the same kind of dynamics. And that's where the kind of coordination that we saw in the late nineties between central bankers around the world to tame the crisis, and that that probably will be necessary again things get that beat. Stephen mim there. We're now choosing to end all conversations not with you, though as always we love to hear from you. I'm at Vonney Quinn on Twitter, or send your thoughts to v Quinn at bloomberg dot net, and we're available as a podcast on Apple, Spotify, or wherever you get your podcasts. Bloomberg Opinion is produced by Eric mollow Till next Time a money Quinn