How the Rising Dollar Could Trigger the Next Global Financial Crisis
We are concerned about the consequences of multi-speed economic growth around the world and the growing divergence between major central banks. In our opinion, if these trends persist, they likely mean (1) a major US dollar rally, (2) a rapid unwind of QE-induced capital flows to emerging markets, (3) a hard slide in fragile emerging-market and commodity-exporter currencies, and (4) financial shocks capable of ushering in a new global financial crisis.
Alongside true macro legends like Kyle Bass, Raoul Pal, Luigi Buttiglione, and Raghuram Rajan, Worth and I have written about this theme extensively in 2014 ( “Central Banker Throwdown,” “Every Central Bank for Itself,” “The Cost of Code Red,” “Sea Change,” “A Scary Story for Emerging Markets”). Now it’s quickly becoming a mainstream macro theme on almost everyone’s radar. Virtually every economist and investment strategist on Wall Street has a view on the US dollar and the QE-induced carry trade into emerging markets… and anyone who doesn’t should start looking for a different job.
Policy divergence is really the only macro theme that matters right now. And on that note, the Bank for International Settlements just released its predictably must-read quarterly review, with an urgent warning:
The appreciation of the dollar against the backdrop of divergent monetary policies may, if persistent, have a profound impact on EMEs [emerging-market economies]. For example, it may expose financial vulnerabilities as many firms in emerging markets have large US dollar-denominated liabilities. A continued depreciation of the domestic currency against the dollar could reduce the credit worthiness of many firms, potentially inducing a tightening of financial conditions.
