Two phases of global liquidity

01 April 2015

On 23 March, Hyun Song Shin, Economic Adviser and Head of Research at the Bank for International Settlements, gave a talk at the CFS Colloquium series about “Financial markets in an interconnected world”. In his lecture Shin addressed two main topics: the changing pattern of financial intermediation since the financial crisis and the global nature of dollar-denominated corporate debt, including in the energy sector.

Shin defined two phases of global liquidity. During the first phase (2003-2008) credit growth was mostly driven by the banking sector with global banks intermediating credits denominated in U.S. dollars. The depreciation of the U.S. dollar coincided with a global lending boom until 2008 when the global financial crisis broke out and capital flows plunged worldwide. By 2010, liquidity flows were surging again but this time predominantly through capital markets. According to Shin, this is the second phase of global liquidity which is characterized by a bond market-led credit growth driven by extraordinarily low long-term yields. Since 2010, creditors are mostly long-term investors with a focus on corporate borrowers, especially from emerging markets.

Shin showed that lenders resident in the United States supplied only a small part of credits denominated in U.S. dollar to borrowers outside the U.S. A larger share was extended by lenders located outside the United States. In this way, depositors and investors outside the U.S. provided most of the credit volume denominated in U.S. dollar to non-U.S. borrowers. In general, there has been a large increase in credits denominated in U.S. dollar to non-banks outside the U.S. between 2000 and 2014, so that the non-financial sector now accounts for an increasingly large share of the credit issued, Shin said. He also showed that the highest increase in these credits can be observed in the emerging market economies.

Finally, Shin outlined that there has been a large increase in debt and leverage in the energy sector (oil and gas producers) during the last years. The stock of debt of energy firms has risen even faster than that of other sectors. A substantial part of the increased borrowing has been done by large oil firms from emerging market economies and by smaller U.S. oil companies. According to Shin, the recently low oil prices have reduced the value of oil assets that have been used to back the high debt, so that credit spreads in the energy sector have gone up since mid-2014. The low oil prices also reduce the cash flows associated with current production and increase the risk of liquidity shortfalls that would make firms temporarily unable to meet interest payments. Firms could respond by increasing their output or they might even be forced to sell assets. This could lead to a further decline in oil prices, Shin explained.