Emerging markets and Asia may be first in the firing line
This time round the rising dollar may be America's currency and everybody's problem.
That's because the dollar's strong rise will serve to crimp global liquidity, making financing more expensive and harder to get, markets more volatile and emerging economies, especially, more risky.
Famously in 1971 then US Treasury Secretary John Connally told Europeans fretting over the falling value of the dollar that "The dollar may be our currency, but it's your problem."
Except whereas the problem with the dollar then, newly de-linked from gold, was that there were too many and the value was falling, now the issue, at least globally, is that in a world with a strongly rising dollar they may be much harder to get hold of.
That, argues Michael Howell of consultancy Crossborder Capital in London, is an issue given the diminished importance of the US economy, now only about a fifth of the global whole but one which produces the currency which accounts for something like 75 per cent of global cross-border transactions.
"The stronger the US dollar, the more expensive and less available is the funding necessary to maintain the momentum of this non-US-leveraged finance," Howell writes in a note to clients.
"And, in turn, this risks a self-sustaining overshoot in the U.S. dollar and downward spiral in global liquidity, as financing lines are liquidated and 'carry trades' forcibly unwound."
Emerging markets and Asia may be first in the firing line, but clearly a system rather precariously balanced on the perhaps undersized foundations of the US economy is capable of creating problems everywhere and for everyone.
Crossborder sees global liquidity, in essence capital available for investing and spending, as contracting by about $10 trillion, or 10 per cent, over the coming year, principally as a result of the rising dollar. Crossborder says its readings on global liquidity serve as a good leading indicator of economic activity, with a six-to-12-month lag, but a much shorter lag for market activity.
With liquidity already in contractionary territory, and expected to head lower, there is good reason to expect more market volatility in the coming year.
China, emerging markets key
Remember that the trade-weighted US dollar made a multi-decade bottom in 2011 and, while it is 15 per cent higher or so now, has room for even more appreciation.
And also, the US contribution to global liquidity isn't even principally about monetary policy, meaning that even if the Fed is unable to hike interest rates, liquidity may find itself crimped globally. By running a large current account deficit, the US helps to supply the rest of the world with dollars which in turn can be available for recycling.
But the growth of US shale oil may tend to cap the current account deficit, as may reluctance on the part of individuals and companies to add to their debts. The IMF is projecting accelerating global growth through 2017 but broadly stable current account deficits.
Another issue is China, as a contributor to global liquidity, a user of it and a potential source of event volatility. Data shows substantial recent outflows of capital from China and Hong Kong. If the yuan is to track the dollar higher, the implication is a potentially sharp fall in liquidity in China at perhaps an uncomfortable time given the slowing of its economy.
This could prompt yet more capital flows out of China, only exacerbating the effects on the parts of its economy which rely on leverage, bank-originated or from the shadow sector. In other words, a vicious cycle.
This in turn might possibly tempt China to devalue the yuan against the dollar, something which, depending on the scale of the devaluation, would cause no end of problems and conflicts. Not only would this add to the global deflationary impulse, making the jobs of the Bank of Japan and European Central Bank that much more difficult, it would also very likely upset any number of financial market apple carts.
And if the circumstances which might goad China into a devaluation exist, imagine how other emerging markets would be affected.
Remember too that past episodes of dollar strength have been both long lasting and prone, as are so many currency moves, to overshooting. We may not have seen the last of dollar strength, and current estimates of its impact on liquidity may be too low.
"Although the 1987 and 2008 financial crises focused on the developed markets, and the 1994 and 1997 crises engulfed the emerging markets, their common root remains the tension between the domestic and international roles of the US dollar," according to Howell.
So long as it remains the dominant currency of international exchange, the dollar will also remain everyone's problem.
James Saft is a Reuters columnist. The opinions expressed are his own