Global cash is getting scarcer and US credit flows are supporting China’s fragile financial edifice: Why the world must prepare for the Fed's QE4

 
Michael Howell
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China will struggle to attract much-needed dollar funding without devaluing the RMB further (Source: Getty)

Liquidity risks remain elevated.

The CrossBorder Capital Global Liquidity Index (GLITM) for September 2015 is stuck at low levels of 39.0 and close to its sub-par August reading.

Such poor liquidity underscores a ‘Risk Off’ investment environment characterised by high volatility and by the likelihood that economic activity levels will weaken noticeably over the next six-12 months. We have already warned that low and falling US liquidity levels point to economic recession by early 2016. Sizeable falls in world stock market always occur at times when, like now, liquidity dries up.

Three key numbers jump out from the September data release. First, US private sector liquidity moved decisively lower in the month.

Second, Chinese net financial capital outflows slowed to $50.2bn(£32.4bn) in September. Although better than the $139.7bn outflow for August, it is another bad number.

And third, very low activity in cross-border funding markets highlights the reluctance of global capital to move. This fact threatens the sustainability of large payments deficits, so warning that sterling looks vulnerable to a fall.

Together the combination of these forces spells a discouraging message of tighter global cash. Global liquidity has largely been fuelled since 2012 by the re-cycling of surplus US dollars from US corporations, rather than by the widely-assumed quantitative easing policies of the US Federal Reserve and other central banks.

Wholesale repo and eurodollar markets have leveraged and distributed these flows internationally, particularly to Chinese and Emerging Market borrowers. These flows confirm that far from Chinese savers bailing out America as some pundits mistakenly suggest, US credit flows instead support China’s fragile financial edifice.

Already, there are signs of stress in US corporate credit markets, and disturbingl,y in international banking, money is starting to be pulled back to America from the eurodollar markets. Both provided timely warnings ahead of the 2007/08 crisis.

With global liquidity thus compromised, China will struggle to attract much-needed dollar funding without devaluing the RMB further. We suspect that these tensions informed the decision by the US Federal Reserve to stay its hand on the slated interest rate rise.

However, their mind-set quickly needs to change towards finding more innovative ways to ease liquidity than tighten. A QE4 is coming. It must.

City A.M.'s opinion pages are a place for thought-provoking views and debate. These views are not necessarily shared by City A.M.

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