1/11/20232 min read

Before I begin this Rapsody, let me run through some Numbers, so you can size up what I’m about to say. ·

  • Global GDP sits at $104 Trillion ·

  • Hidden Dollar Debt close to $65 Trillion ·

  • Current US Debt is $31 Trillion

The scale of hidden dollar debt in the global financial system is staggering.

$65 trillion in unrecorded dollar debt is estimated to circulate in non-U.S. banks and shadow banks. To put this into perspective, this amount is roughly equivalent to more than 60% of the total global GDP, which currently stands at approximately $104 trillion.

This dollar debt primarily takes the form of foreign-exchange swaps, which have experienced unprecedented popularity over the past decade. This can be attributed to a confluence of factors, including years of monetary easing and ultra-low interest rates and investors' ongoing search for higher yields. Today, the unrecorded debt from these foreign-exchange swaps is estimated to be worth more than double the dollar debt officially recorded on the balance sheets of these institutions.

Foreign-exchange (forex) swaps are agreements between parties to exchange one currency for another. They are used to reduce the risk of currency fluctuations for companies that generate revenue across borders. The forex market is the largest in the world and plays a critical role in the global economy. The key players that use forex swaps are: Corporations, Financial institutions, and Central banks.

However, due to accounting rules, forex swaps are often unrecorded on balance sheets, which are quite opaque. This lack of transparency challenges regulatory bodies and creates risks for the global financial system.

Furthermore, driving its rise in part was an era of rock-bottom interest rates globally. As investors sought out higher returns, they took on greater leverage—and forex swaps are one example of this. Because demand for U.S. dollars increases during market uncertainty, a worsening economic climate could expose the forex market to more vulnerabilities.

Non-U.S. and shadow banks, unregulated financial intermediaries, have been heavily exposed to this form of unrecorded debt. An estimated $39 trillion is held by non-U.S. banks, along with $26 trillion in overseas shadow banks worldwide.

During the market crashes of 2008 and 2020, forex swaps faced a funding squeeze. To borrow U.S. dollars, market participants had to pay high rates. This put pressure on funding rates and hinged on the impact of extreme volatility on these swaps. In order to prevent dollar shortages, The U.S. central bank had to step in and provide liquidity in the market by pumping cash into the system and creating swap lines with other non-U.S. banks such as the Bank of Canada or the Bank of Japan.

However, the risk from growing dollar debt and these swap lines arises when a non-U.S. bank or shadow bank may be unable to hold up their end of the agreement. Daily, an estimated $2.2 trillion in forex swaps are exposed to settlement risk. Given its vast scale, this dollar debt could have greater systemic spillover effects. If participants fail to pay it could undermine financial market stability and potentially harm the global economy.

In conclusion, the scale of hidden dollar debt circulating in the global financial system is truly staggering, with an estimated $65 trillion in unrecorded dollar debt circulating in non-U.S. banks and shadow banks, which is more than 60% of global GDP. This trend of growth in hidden dollar debt is concerning and carries significant implications for the broader global economy and financial system, and it's crucial for regulatory bodies to keep a close eye on this phenomenon and take action to mitigate the potential risks.