Why being the king of currencies has its pitfalls

Wed May 11, 2016 7:00pm EDT
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By Mike Dolan

LONDON (Reuters) - The world is getting an object lesson on the problems of having one dominant global currency and even the supposed prime beneficiary, the United States, can see the downside.

Alarming bouts of volatility in world financial markets over the past 12 months have been rooted in a fear of what happens when a world with its highest-ever peacetime debt pile faces even a hint of higher interest rates.

Despite a constant narrative about U.S. households and banks paying down debts ever since the global credit crash eight years ago, any 'deleveraging' that did happen was more than offset by higher government, corporate and personal debt around the globe in Europe, China and across emerging markets.

In fact, aggregate world debt is now far higher than it was before the 2007-08 crash.

"The saga of debt is far from over," says a report from Morgan Stanley. It goes on to explain why Morgan Stanley expects demographic-led shifts in savings and investment to soon push interest rates higher and transform that debt mountain into additional deadweight on world growth over next five years.

But the role of the U.S. dollar as the world's main reserve currency denominating large chunks of that debt pile is showing up as complicating factor that's added to risk of instability.

The first U.S. interest rate increase in almost a decade in December - just a quarter of a percentage point - was enough to trigger a convulsion in world markets that led to the worst start to a year for global stocks since World War Two.

Underlining 'cause and effect', the subsequent recovery only came about once the Federal Reserve hastily made clear it was pressing the pause button precisely because of seismic events in world finance.   Continued...

A man wears U.S. dollar sign rings in a jewellery shop in Manhattan in New York City November 6, 2014. REUTERS/Mike Segar