Economic Disconnect Mention
On the blogroll, you may know the site Some Assembly Required. This site is a daily stop for me and I really enjoy the authors work. I was very surprised and excited than an article of mine found it's way onto a post over there today. My entry is the 7th one down under "The Question". A real treat for this author!
This week I had discussed how this blog's readership was down. From what I could gather it seems many are just tired of the games and tired of the same old, same old in the markets (or maybe my writing!). Well there may be something very different in the works that is worth some attention.
The discussion about the future of the dollar is still raging full force after a big kickoff this week. The dollar of course does not exist alone, and currencies are entwined in ways I really cannot comprehend.
To start, currency debacles tend to have outsized effects, even if their relative scale is not such that one would think so. Consider:
1994 Mexican Peso Crisis
While swiftly addressed, it had all the markings of a serious problem.
1997 Asian Financial Crisis
The floating of the Thai baht (butt?) caused widespread damage across the globe
1998 Russian financial crisis
The Russian debt default not only sealed the doom of Long Term Capital Management, but almost caused the first "systemic risk" meltdown which was delayed until 2008.
From these three examples I take away that currency problems can be the cause of serious market dislocations across the globe. With an eye towards that angle, lets take a look at this weeks developments.
This nonchalant piece really dismisses the news as something not going to happen soon. I wonder what the headlines about the Thai baht were like the day before:
Latvia on the brinkFair enough I guess, but of course we have no idea what exposure these banks have.
LONDON (MarketWatch) -- It's never good news when a government bond auction fails. It's particularly bad news when an auction fails for a note maturing in just six months. And it's really bad news when there isn't any bid at all.
Were Latvia to devalue, that would hit economies in neighboring countries like Lithuania, and Swedish banks would rack up additional losses on the loans they have made throughout the region. The real nightmare scenario would be the Swedish banks then pulling down other European banks, and then triggering Credit Crunch: Part 2.
There is, of course, a long way before that unwieldy scenario comes to pass. Latvia hasn't devalued -- yet - and, even if it does, that doesn't mean it would drag the Swedish banks under.
Adding to this is another subtle wrinkle that I think has importance on a much grander scale (FT, via Naked Capitalism):
Latvia denies plan to devalue currencyAnd so a ripple near a coast spreads across the world.
...Riga announced tentative plans on Tuesday to cap the amount that banks would be allowed to collect from mortgage holders in a move that analysts said would make it easier for Latvia to devalue....
...The Latvian proposals would allow banks to collect only the current value of a property rather than the original value of the mortgage, insulating homeowners from the 70 per cent drop in property prices since their peak.
To me, this is huge. One of the most vexing issues on the table right now is the "Delay and Pretend they will Pay" game being played by the banks. Banks hold many mortgage backed assets (both residential and commercial) at near par values. They refuse to take marks against them. They will willingly roll over commercial debt or allow residents to remain in a home indefinitely rather than force a foreclosure and take a hit to the value of the loan.
We have seen that mortgage "cramdowns" have not become viable yet, due mainly to the push back of the banks. They fall back on the delay plan.
If the lower tranche holder is 100% sure by government (think US state to extrapolate) proclamation that they will never see their money, then this game is up. The banks can pretend all they want, but they will be out of time and out of new money investors.
I am not saying this WILL happen, only that in desperation I would not be shocked to see entities resort to such a thing. Just like mortgage holders just "walking away", the banking system is arrogant beyond belief that people will pay their debts no matter what. Ivory tower and all that. Try living in a poor city and then get back to me.
Sticking to the currency theme, the falling dollar is causing many countries to try and protect their competitive edge. This is draining reserves of those countries and again, we know currency problems can go a long way. Consider (via Zero Hedge):
Asian tigers roar back at US Dollar
I advise reading the whole thing, but take away point:
Overnight, we witnessed intervention by various Asian central banks to suppress their own currencies against the Dollar. The banks of South Korea, Taiwan, the Philippines and Thailand all intervened to prevent appreciation of their currencies. The Bank of Korea bought $1billion. The Bank of Indonesia bought $350 million. The Phillipines' central bank bought $100 million. The Hong Kong monetary authority sold $3.88 billion Hong Kong Dollars to support its dollar-peg. The Yen is at 88.24, but there was no intervention by the BOJ, at least none that we could confirm.Scrambling to keep pace with the US dollar fall is sure to cause some kind of imbalance as those funds (large on a relative scale) are committed to currency moves.
These are serious moves. Why is this not front page news? It is difficult to tell whether these are simply more dramatic fluctuations on the world markets, or the start of a new phase in the crisis. What will be imperative is to pay close attention to the actions of global central banks in the days ahead. Currency is key. The next four weeks should be quite interesting indeed.
From Clusterstock, another angle:
Asia Will Ambush Dollar Shorts Over And OverAnother "the dollar will never fall" call.
Thursday's coordinated currency intervention by South Korea, Taiwan, the Philippines, and Thailand is just the start of what will happen should the dollar keep sliding.
Most export-heavy countries around the world are far from ready to address the hard changes at home required to deal with a weak-dollar world.
Their economies are growing fast. Yet for many leaders, this speedy growth is the only real legitimacy they have with their citizens, without which they could be in deep trouble.
Thus they'll fight tooth and nail to forestall any change from the status quo whereby Americans consume, while they produce and grow...
...While dollar shorts probably have long-term trends in their favor, many will be made into unfortunate examples by aggressive central banks along the way. Traders beware.
I would submit that if the dollar keeps declining, the export countries (China excluded) simply do not have enough ammo to fight back. This is how a currency crisis happens. History shows us how serious this can be.
In closing (warning, more of the same old, same old) the one drawback of fiat currencies is that they are built entirely on confidence. Fiat currency can do all the "stupid pet tricks" the central banks want as long as confidence that the pet will perform holds.
Why is devaluation so disruptive? The same reason mortgage defaults are so disruptive, lenders/creditors just cannot believe you are going to stiff them. In their mind they are doing YOU a favor by loaning you more money than you can pay back, and at onerous terms, so you should do what you have to do for full payment.
When this does not happen by revolt (through devaluation or default) the system loses confidence because their bluff was called.
The world has seen devaluation many times in the last 100 years (US in the 30's still on the gold standard, US in the 70's walking away from the gold standard, Argentina 2 times, the three examples above, and Latvia maybe in the next month) so why the shock and awe? This is because it attacks the very premise of fiat currency.
I am moving to a stance that world money moves bear watching, and as the US markets seem as boring and predictable as can be for months, maybe you will watch too.
With all the discussion of Latvia, I could not help but think about "The Wizard of Riga", former world chess champion Mikhail Tal. A true genius, I have studied his games many times and am still blown away by his brilliance and inventiveness.
Have a good night.