Dollar Bull Is Deflation

The most common misconception about the U.S. dollar bull market is that the dollar is somehow inherently strong. It is not, but that doesn't mean it won't continue to scale ever greater heights as debt is repaid or defaulted upon.

SCMP: US dollar owes its strength to one simple thing: the world's need to repay a mountain of debt

But the absolute level of global dollar-denominated debt is less important than the fact that the stock of debt is growing as a percentage of world gross domestic product. The debt is arguably becoming more burdensome.

World debt had risen to above 210 per cent of global GDP in 2013, up from some 180 per cent in 2008, according to August's Geneva Report on the World Economy.

In truth, the world may well have borrowed beyond what it can easily afford to repay, and what it owes, it mainly owes in dollars.

"Most central bankers know that our economies do not face a liquidity problem but a solvency problem linked to excessive debt accumulation," said William White, chairman of the economic and development review committee of the OECD, in a recent interview.

Central banks, with the US Federal Reserve at the forefront, addressed liquidity problems at the start of the global financial crisis in 2008, when the collapse of Lehman Brothers triggered a seizure in the world's financial markets, by pumping money into the system, providing cheap and plentiful funds over the following years.

But the availability of cheap dollars may have resulted in dollar-denominated debt-financed investment decisions which now seem less economically well-grounded.

Money supply is made up of money and credit. The growth of U.S. dollar credit is the inflation; the repayment of debt is deflation. During the dollar inflation in the 2000s, the U.S. dollar declined. In the credit inflation post-2008, the U.S. dollar did not decline versus the developed market currencies at all (U.S. Dollar Index) and it didn't fall very far versus emerging market currencies. This round of deflation and U.S. dollar appreciation is starting from a higher level of total credit and a higher initial U.S. dollar level. The final U.S. Dollar Index reading at the end of this cycle will be far above current market expectations.