A Chinese submarine is seen as part of the celebrations for the 60th anniversary of the founding of the People's Liberation Army Navy, off Qingdao, China, on Thursday, April 23, 2009.  Fifty-six Chinese subs, destroyers, frigates and missile boats took part in the celebration display. Photographer: Guang Niu/Pool via Bloomberg News

Military tension between China, Japan and the US is rising.

We enter the year of the all-conquering US dollar. As the global security system unravels - with echoes of 1914 - the premium on the world’s safe-haven currency must rise.

The effect is doubly powerful since the US economy is simultaneously coming back to life.

America has shaken off the most drastic fiscal tightening since the Korean War, thanks to quantitative easing. Growth is near “escape velocity” - at least for now - at a time when half of Europe is still trapped in semi-slump and China is trying to cool the world’s most dangerous credit boom.

As the Fed turns off the spigot of dollar liquidity, it will starve the world’s dysfunctional economy of $US1 trillion a year of stimulus. This will occur through the quantity of money effect, hitting in a series of hammer blows, regardless of whether interest rates remain at zero. The Fed denies that this is “tightening”, and I have an ocean-front property to sell you in Sichuan. It is hard to imagine a strategic and economic setting more conducive to a blistering dollar rally, a process that will pick up speed as yields on 10-year US Treasuries break through 3pc.

The annual rite of new year predictions is never easy. It is nigh impossible in the midst of a global regime change with so many political bombs primed to go off at any moment.

In case you had forgotten, China has imposed an Air Defence Indentification Zone (ADIC) covering the Japanese-controlled Senkaku islands. The purpose of this escalation in the East China Sea is to test US willingness to back its military Alliance with Japan, just as Kaiser Wilhelm provoked seemingly petty disputes with France to test Britain’s response before the First World War.

The ploy has been successful. The US has wobbled, wisely or not depending on your point of view.

While American airlines comply, Japanese airlines fly through defiantly under orders from Japan’s leader Shinzo Abe. Mr Abe has upped the ante by visiting Tokyo’s Yasukuni Shrine - the burial place of war-time leader Tojo - in a gesture aimed at Beijing.

Asia’s two great powers are on a quasi-war footing already, one misjudgement away from a chain of events that would shatter all economic assumptions. It would leave America facing an invidious choice: either back Japan, or stand aloof and let the security structure of East Asia disintegrate.

Trade this if you wish. The Dow Aerospace and Defense index (ITA), featuring the likes of Raytheon and Lockheed Martin, has risen 60pc over the past year, compared with 29pc for Wall Street’s S&P 500.

Fuji Heavy Industries (robotics) is up almost 200pc this year in Tokyo, and Yamaha (also robotics) has doubled. Equities are pricing in rearmament. Japan raised spending on military equipment by 23pc last year. It has launched an 800-foot long DDH-class helicopter carrier, an Osprey aircraft carrier in all but name.

The US is stepping back from the Middle East, leaving the region to be engulfed by a Sunni-Shia conflict that resembles Europe’s Thirty Years War, when Lutherans and Catholics battled for supremacy. Sunni allies are being dropped, Shia Iran courted. Even Turkey risks succumbing, replicating Syria’s sectarian fault lines.

Some blame Barack Obama for abdication, but the roots lie in two botched wars before him.

Besides, Gulf oil is passe. Shale promises to turn the US into the world’s top oil producer by 2017.

In Europe, the EU Project has by now lost so much caste that Ukraine’s leaders dare to tear up an association accord, opting instead for a quick $US15 billion from Vladimir Putin’s Russia. We seem to be reliving the mid-17th century when Bohdan Khmelnytsky turned his back on the West and embraced Tsarist suzerainty, locking Ukraine’s borderlands into Russia for the next 300 years.

This is our brave new world of 2014. The democracies are on the back foot. It is no longer Francis Fukuyama’s “End of History”, but history returning in tooth and claw.

So with that caveat let me try to make sense of global economic forces. Bearish as usual, I doubt that we are safely out of the woods, let alone on the start of a fresh boom. How can it be if the global savings rate is still rising, expected to hit a fresh record of 25.5pc this year? There is still a chronic lack of consumption.

As the Fed tightens under a hawkish Janet Yellen, a big chunk of the $US4 trillion of foreign capital that has flowed into emerging markets since 2009 will come out again. It is fickle money, late to the party.

Some say last May’s “taper tantrum” was a timely tremor that released pressure and gave the BRICS and mini-BRICS a few months to adjust. This is oddly complacent given warnings by the International Monetary Fund, a body that specialises in such “sudden stops”. As the IMF says, the taper tantrum may equally be a foretaste of something worse.

The Bank of England’s Mark Carney says the epientre of stress in global finance now lies in the shadow banking system of emerging countries. My guess is that the Turkish lira will be the “Thai baht” of this episode - for those who recall the East Asian crisis of 1997-98 - although it could be a multiple fuse of those with big current account deficits, whether Egypt, Niger, Ukraine or South Africa, spreading thence to the next tier of Brazil, India and Indonesia.

It is a myth that emerging markets borrow only in their own currencies these days. External debt will reach $7.36 trillion in 2014, double 2006 levels (IMF data), mostly in dollars. Some $2 trillion is short-term. It must be rolled over continuously.

Euroland will be hit on two fronts by Fed action. Bond yields will ratchet up, shackled to US Treasuries. Emerging market woes will ricochet into the eurozone. The benefits of US recovery will not leak out as generously as in past cycles. Dario Perkins from Lombard Street Research says the US is now more competitive than at any time since the Second World War. America is poised to meet its own consumption, its industries rebounding on cheap energy. Europe will have to generate its own stimulus this time. Don’t laugh.

The European Central Bank can counter imported tightening by loosening pari passu, with a €1 trillion blast of QE that ingites the wet kindling wood. That would require a Damascene conversion in Frankfurt, or a debtors’ cartel of Latin states to wrest control of policy and force through reflation. Such a cartel is taking shape. Chancellor Angela Merkel was badly mauled at the EU’s December summit. Romano Prodi - former “Mr Euro” - has called for France, Italy and Spain to join forces and “bang their fists on the table”. But no leader has yet emerged.

The ECB’s Mario Draghi has, of course, eliminated the acute tail-risk of sovereign defaults in Italy and Spain with his bond-buying ruse, though the German constitutional court has yet to rule on the scheme. All five expert witnesses questioned its legality. But even assuming there is no bombshell from Karlsruhe, the deeper crisis keeps grinding on.

Credit to firms is still contracting at a rate of 3.7pc, or 5.2pc in Italy, 5.9pc in Portugal and 13.5pc in Spain. This is not deleveraging. The effects have been displaced onto public debt, made worse by near deflation across the South.

Italy’s debt has risen from 119pc to 133pc of GDP in three years despite a primary surplus, near the danger line for a country with no sovereign currency. For all the talk of reform - Orwellian EMU-speak for austerity - Italy is digging itself deeper into one hole even as it claws itself out of another, its industries relentlessly hollowed out. Much the same goes for Portugal and, increasingly, France.

Markets cannot be counted on to stop this. They often abet destructive policies. Europe’s wasting disease can go on for a long time, so like the Gold Standard years of 1934 and 1935.

There is just enough growth on offer this year - the ECB says 1pc - to sustain the illusion of recovery. Those in control think they have licked the crisis, citing Club Med current account surpluses. Victims know this feat is mostly the result of crushing internal demand. They know too that job wastage is eroding skills (hysteresis) and blighting their future. Yet they dare not draw their swords. It will take politics - not markets - to break this bad equilibrium, the moment when democracies cease to tolerate youth unemployment of 58pc in Greece, 57.4pc in Spain, 41.2pc in Italy and 36.5pc in Portugal.

The European elections in May will be an inflexion point. A eurosceptic landslide by Marine Le Pen’s Front National, Holland’s Freedom Party, Italy’s Cinque Stelle and Britain’s UKIP, among others, will puncture the sense of historic inevitability that drives the EU Project.

French leader Francois Hollande will have to choose between conflicting loyalties to the Project and to the Parti Socialiste, fast shedding support to “Left Le Penism”. He will opt for his own political survival and for the French national interest, now closely aligned. There will be no showdown with Berlin, just a series of escalating tiffs. The Franco-German EU marriage will die the death of a thousand cuts.

Latin rebels will increasingly invoke the example of the US - and loosely the Anglo-Saxon QE bloc - as it pulls ever further ahead. The US outgrew Euroland by three percentage points in 2012 and again in 2013. US growth may be 2pc higher in 2014, with powerful compound effects.

The jobless rate was similar on both sides of the Atlantic in 2009. It is now at a five-year low of 7pc in the US, and a near record 12.1pc in Euroland.

It is becoming harder to disguise this from Europe’s citizens. By the end of 2014 the macro-policy failure in Europe will be manifest. We forget now how the “demonstration effect” of the Reagan boom was the coup de grace for the dying Soviet model. All pretensions were empty by 1986. That is when the last apologists for Soviet misgovernment stopped defending it and melted away. It was a moral collapse in the end.

Over all else hangs the fate of China. The sino-bubble is galactic. Credit has grown from $9 tillion to $24 trillion since late 2008, as if adding the US and Japanese banking systems combined. The pace of loan growth - 100pc of GDP over five years - is unprecedented in any major economy, eclipsing the great boom-bust dramas of the past century.

The central bank is struggling to deflate this gently, with two spasms of credit stress in the past six months. I doubt it will prove any more adept than the Bank of Japan in 1990, or the Fed in 1928, and again in 2007. This will be a bumpy descent.

China may try to cushion any hard-landing by driving down the yuan. The more that Mr Abe forces down the Japenese yen, the more likely that China will counter with its own devaluation to protect the margins of it manufacturing industry. We may be on the brink of another East Asian currency war, a replay of 1998 but this time on a much bigger scale and with China playing a full part.

If so, this will transmit an a further deflationary shock through the global system, catching the West sleeping with its defences against deflation already run down. The US may be strong enough to cope. For Europe it would be fatal. The denominator effect would push Club Med into a debt compound spiral. Let us give it a 30pc probability. Happy new year.

The Daily Telegraph