80 Trillion USD in missing debt?
I have seen so many atrocious takes on this story, that I feel the need to clarify a few things
A thread 1/n
I have seen so many atrocious takes on this story, that I feel the need to clarify a few things
A thread 1/n
So what is this missing USD debt?
Well, it is basically made up by FX hedges by your local pension fund and your local export company
It is a 100% standard practice by companies- and institutions that operate across borders to use these type of instruments to hedge risk
2/n
Well, it is basically made up by FX hedges by your local pension fund and your local export company
It is a 100% standard practice by companies- and institutions that operate across borders to use these type of instruments to hedge risk
2/n
A European pension fund -or a European export company either holds USD assets or expects to receive USDs in return for future sales..
In both cases they have USD receivables at a known or unknown future date
3/n
In both cases they have USD receivables at a known or unknown future date
3/n
To hedge the risk of the USD dropping in value before this known or unknown date of receival, the pension fund or the export company sells USD forward to create a derivative position that will GAIN if the USD drops in value
4/n
4/n
The pension fund is likely to have a permanent position in USD assets, which means that the hedge needs to be rolled with a fixed frequency to continously hedge the FX risk
An FX swap is used to roll the maturity of the hedge continously
5/n
An FX swap is used to roll the maturity of the hedge continously
5/n
Remember that an FX swap agreement is a contract in which one party borrows one currency from, and simultaneously lends another to, the second party.
Meaning that this is a collateralized loan
6/n
Meaning that this is a collateralized loan
6/n
It is an issue for this market if the USD appreciates fast as the Pension Fund or the Exporter would typically be exposed to mark to market risks of the FX swap agreement on a net/net basis..
USD up -> negative mark to market for the pension fund / exporter
7/n
USD up -> negative mark to market for the pension fund / exporter
7/n
In other words, the Pension Fund or the Exporter is short USD in forward terms, which leaves them at risk should the move in the USD prove to be fast and violent, which often coincides with stress in USD funding markets
8/n
8/n
This "hidden USD debt market" is growing over time as the amount of USD assets is growing over time and as economic activity in USDs is growing over time... It is a complete nothing burger, but...
9/n
9/n
It is fair to say that this outstanding of FX swaps tend to exaggerate moves in the USD (and to a certain extent force selling of USD assets) when there is a sudden shock to the financial system .. For example during the March-2020 covid chock
10/n
10/n
But.. it is not as if we don't know what this USD debt market is.. it is a completely straight forward market with a very important day to day role in the FX/liquidity handling from pension funds and export/import companies..
11/n
11/n
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