Next Dollar Liquidity Crisis

The man who accurately forecasted both the beginning and the worst of China’s stock boom now predicts a financial crisis in China. And that crisis may spread across the globe. The crux of his argument is that when a nation does not have enough dollars (dollar liquidity) it is prone to an economic crisis. Bloomberg Business writes about risks of the next dollar liquidity crisis.

A shortage of dollars was the common feature in the oil rout in the 1970s, Latin American debt turmoil in the 1980s, the Asian currencies collapse in 1997 and the global crisis in 2008. Next year will see Federal Reserve interest-rate increases, an improving U.S. current-account balance and a stronger greenback, putting strains on the most-leveraged parts of the world’s second-largest economy.

“Historically, every time the U.S. current account improved, concurrent with dollar strength, some country somewhere in the world plunged into some sort of crisis,” Hong said. “The pressure from a Fed tightening and thus a dollar liquidity shortage scenario will more likely show up” in Hong Kong property as well as China’s online lending and high-yield corporate bonds, he said in an interview.

When everyone expected the Yuan (RNB) to continually increase against the USD, borrowers preferred debt in USD. Now that the Yuan is on the verge of free fall there is a shortage of dollars to pay off debt, the next dollar liquidity crisis.

The Flow of Capital

Money flows to where risk is the least and profit is most likely. As China copes with a falling Yuan, those with the cash are moving it out of China and into North America, the EU and Great Britain. The underlying concern is that China will be unable or unwilling to part with an unsustainable of growth model of investment and exports. The Financial Times speculates on how China affects the global outlook for the next few years.

Next year will provide conclusive evidence on whether plans to rebalance the economy towards consumption and continue with financial liberalization have gone out of the window. If they have, China will pay a higher price later on for perpetuating a hugely costly misallocation of resources.

The rest of the world also stands to pay a price. A malign external outcome of China’s unsustainable growth model is that returns in many industries have been depressed because of the Chinese contribution to global excess capacity. That is an undermentioned factor in the low levels of investment by industry in the US and much of Europe since the financial crisis.

As the Yuan falls and business gets worse in China, cash flows offshore, setting up the next dollar liquidity crisis.

Where Is the Dollar Heading?

One of the aspects of a dollar liquidity crisis is that the dollar gets stronger. This has been the case for the last few years. However, now that the U.S. Federal Reserve has raised rates it appears that the market had already priced in the rate increase. And, since the Fed says that it will make other raises ever so slowly and carefully there is a chance that the dollar will correct and not head a lot higher. Thus, the next dollar liquidity crisis, if it happens will have to do with a shortage of cash in the nation at risk and not so much with a strong USD.