The Sino-American commerce warfare is rattling markets, however a lesser-appreciated and probably vital tail danger is lurking off the coast of China.
Taiwan could also be small, however the island has emerged as a monetary superpower because of the thriftiness of native savers and an eye-watering present account surplus of about 15 per cent of gross home product. The nation now has the second-largest monetary system on this planet, relative to gross home product. And its life insurance coverage trade is the largest, with assets-to-GDP of 145 per cent, based on JPMorgan.
The native financial system just isn’t sufficiently big to accommodate these huge sums, so Taiwanese monetary establishments have funnelled a whopping $1.2tn overseas. Different international locations have massive abroad stashes of cash, however largely within the type of central financial institution reserves or sovereign wealth funds. Taiwan is anomalous each by way of the scale relative to its financial system, and that this pool of cash consists of personal, quite than public financial savings.
The cash has been invested conservatively, largely in US authorities and company bonds with excessive credit score rankings. However there’s a widening hole between the US greenback liabilities of the insurance coverage sector and the US greenback property the insurers have gathered, rising from 34 per cent of complete steadiness sheets in 2013 to only below half in the present day, on JPMorgan estimates. In greenback phrases, the mismatch quantities to about $420bn, or 72 per cent of Taiwan’s GDP.
That’s worrying. Foreign money exposures have traditionally been hedged on a rolling foundation however nowadays they’re more and more unhedged, given the rising value of shopping for safety in opposition to FX actions. If the Taiwanese greenback had been to weaken, it may set off losses far past the measly coupon funds which are collected on the bonds, forcing the nation’s insurers to drag again from the US market.
That is arguably a systemic danger. Taiwanese insurers maintain about four per cent of the whole US investment-grade company bond market, and 14 per cent of longer-term company bonds, based on JPMorgan. Insurers’ holdings of US mortgage-backed securities have almost doubled over the previous 5 years, to $260bn. That makes Taiwan the second-biggest overseas proprietor of such securities.
That’s not all. Taiwanese banks have additionally turn into massive gamers within the Fed funds market, the place US rates of interest are set, now accounting for about 12 per cent of all buying and selling quantity. It’s due to this fact potential that home monetary ructions in Taiwan may even have an effect on the implementation of US financial coverage.
Authorities in Taiwan have tried to grapple with these points, via regulatory measures that try and ameliorate the rising forex dangers. However this has turn into a recreation of whack-a-mole, with insurers discovering revolutionary methods to skirt restrictions — reminiscent of growing a $14bn marketplace for Taiwan dollar-denominated change traded funds that merely purchase US greenback bonds.
To date the US-Taiwan monetary entanglement has been useful to either side. However deterioration is a danger that buyers want to pay attention to — particularly at a time when markets are already frazzled.