Fiscal stimulus can provide some reprieve and even a bit of a spark, but without growth in money supply (through actual money creation), it is unlikely to lead to any kind of robust and sustained recovery.

Does this mean that the head of the IMF’s concerns will not come to pass, and that there will be no capital outflows from emerging markets to the US, leading to an EM debt crisis?

Ironically, no. If policies continue down their current trajectory, that is “More QE!”, and “More and larger fiscal stimulus!”, capital will still flow to the US, and EM’s will still face a debt crisis.

How is this possible?

It is possible because EMs, and the rest of the world, are dependent on USD liquidity. Unfortunately for all of them, the only central bank that can issue USDs is the Fed.

While the Fed has past form with stepping directly to alleviate global USD shortages in 2008 and March 2020 (USD Swaps with foreign central banks), they tend to do so only in times of acute stress. That is, when the crisis is already upon everybody else.  

The Fed won’t step in directly to provide USD liquidity in international markets before a crisis flares up (or at least, they have not done so before) for a handful of reasons.

Firstly, crises are almost impossible for them to predict firsthand, even when others can (‘08 and ‘20 are both examples of this).

Secondly, it isn’t in their mandate to provide USDs to anyone other than the US banking system.

Thirdly, the Fed either does not realize the importance of USDs globally, and/or completely fails to understand how the international USD market works.

As you can see, the third reason actually feeds directly into the first and second ones. The Fed simply does not see that it needs to pay attention to the global Eurodollar market, not just banks in America. Although, thankfully, this is beginning to change with their introduction of the standing FIMA facility. 

Consequently, when USDs are hard to come by in the Eurodollar market due to collateral constraints and/or banks’ reduced appetite for risk, EMs do everything they can to secure the USDs they need.

This occurs in two phases; in the first, they scramble to sell as many of their current Treasury holdings as they can in order to meet their immediate USD liquidity needs.

Which is why at the beginning of most crises, UST yields tend to spike higher for a short period of time, baffling the media and mainstream commentators, before proceeding to do what everyone expects and tumble lower.

Tumbling yields mark the start of the second phase, where EM governments and institutions hoard whatever USTs they have left*.

This hoarding occurs as international Dollar funding/repo markets seize up, and financial institutions all over the world rush to get their hands on scarce USTs. All of which results in surging demand, lower yields, and even more collateral scarcity.

Both phases often occur concurrently with large spikes in USD exchange rates all over the world.

That is, the USD very rapidly strengthens in value relative to EM currencies, as banks and businesses scramble to obtain the Dollars they need from a global financial system that is no longer willing to provide them. The very definition of capital outflow.

Naturally, while the global financial system is scrambling for USDs, EM interest rates will have also skyrocketed as investors in EM fixed income sell their holdings to avoid further losses.

These higher rates will hinder their ability to service their debts, but the damage this causes will be far outweighed by that of the now much stronger USD.

*Remember that EMs need USDs at this point in time, and generally won’t be buying USTs because they are using their available Dollars to meet their financial system’s USD based liabilities

To be concluded…