[The Editors' Verdict] Companies Hoarding Dollars

Professor Kim Kyung-soo, Department of Economics, Sungkyunkwan University

Last week, the U.S. Federal Reserve (Fed) expanded its currency swap lines to nine countries, including South Korea, as the value of the dollar soared due to the COVID-19 pandemic. This move, reminiscent of the global financial crisis in October 2008, aims to stabilize the dollar exchange rate and facilitate securing dollar liquidity. Although the news of the Korea-U.S. currency swap agreement briefly restored calm in the financial markets, experts caution that it is not a reason for complete reassurance. Volatility can expand at any time depending on the international financial markets.

The current instability in the global foreign exchange markets is largely due to companies, financial institutions, and investors hoarding dollars as if stockpiling goods. This chaos arose when the U.S. economy halted due to the spread of COVID-19, causing corporate cash flows to stop. As corporate cash flows ceased, the risk of default for indebted companies increased, spreading this risk throughout the financial sector. Just as no one can escape the risks of the pandemic, companies, financial institutions, and investors with dollar-denominated debt and maturity mismatches are sucking in dollar liquidity like a black hole.

Except for some companies like major IT firms that have accumulated cash reserves, most companies are deficit economic agents with expenditures exceeding income. They raise funds by borrowing from banks or financial institutions or by issuing securities in the capital markets. Under low interest rates, companies have taken on significant debt. According to the Bank for International Settlements (BIS), at the end of 2019, the debt of U.S. non-financial corporations reached $16 trillion, equivalent to 75.3% of GDP.

Among these, leveraged loans?loans to companies with low credit ratings or high debt?are estimated to total $1.2 trillion. Due to strengthened prudential regulations, banks sold these leveraged loans to the market instead of holding them as assets. Asset management companies that purchased these loans bundled them into Collateralized Loan Obligations (CLOs) and sold them to private equity funds and others. CLOs, which enjoyed popularity for their high returns under low interest rates, are now in a similar position to mortgage-backed securities (securities structured from subprime mortgages) that triggered the 2008 financial crisis. This is because the default risk of leveraged loans is soaring.

The commercial paper (CP) market, which finances short-term operating funds for highly creditworthy large corporations, is also freezing up. This is why the Fed reopened lending windows and promised to cover losses for money market funds (MMFs) reluctant to purchase CPs.

Professor Robert Shiller, author of narrative economics, diagnosed that "the stock market crash is driven not only by the actual risk of the virus but also by people's fear." Ultimately, only when the end of the pandemic is in sight or when people gain confidence that the risk is manageable will fear subside and the market stabilize.

Many experts believe that the decade-long U.S. economic boom has ended and a recession has already begun. This is because the more actively the pandemic is addressed, the more economic activity inevitably contracts. Unemployment claims are already surging, and layoffs are occurring in industries such as airlines, hotels, automobiles, and food services. Economic forecasting agencies predict that the U.S. economy will experience double-digit negative growth (%) in the second quarter. The longer the pandemic lasts, the less likely green shoots (economic rebounds amid downturns) will appear, and it is inevitable that heavily indebted companies and startups will face more bankruptcies and unemployment will rise further.

When the U.S. economy falls into recession, the growth engine of the global economy inevitably stops. This is because there is no country realistically capable of leading the global economy in place of the U.S. For our economy, which relies entirely on exports, this is frustrating. Above all, the debt of South Korea’s non-financial corporations, exceeding 100% of GDP, is expected to be a vulnerable link to the pandemic.

Kyungsoo Kim, Professor Emeritus, Sungkyunkwan University

This content was produced with the assistance of AI translation services.