In the last few weeks, the currency market is where the action has been. We have witnessed massive moves in every major currency and in some not so major ones. To my mind, all of this is a prelude to some sort of currency crisis.
This crisis has been sneaking up on us as most of us have been transfixed by the U.S. subprime crisis and the subsequent credit crisis. For some currencies, it has been a sickening ride. The U.S. Dollar plunged to 1.60 to the Euro only to snap back viciously to 1.25. The U.S. Dollar plummeted to below 2.10 to the British Pound but is now above 1.60. All of this in the space of a few months.
But, it is in commodity and emerging market currencies where the trouble is brewing. First, we saw a nightmarish plunge of the Australian and Kiwi Dollar as commodities plummeted. This all out assault on commodity and emerging market currencies then widened to include the Icelandic Krona, the South African Rand, the Polish Zloty, the South Korean Won, the Hungarian Forint, and the Mexican Peso amongst others.
This speaks to hot money fleeing emerging markets wholesale as the carry trade started to unwind. And I have slowly started a drumbeat of concern regarding these events. However, today, I caught two interesting perspectives on this debacle that made me blanch. One was the cover story in the Economist.
A few months ago, many emerging economies hoped they could take mass casual leave from the credit crisis. Their banks operated far from where the blood was being shed. The economic slowdown evident in America and Europe was regrettable, but central bankers in many emerging economies, such as India and Brazil, were busy engineering slowdowns of their own to reverse high inflation. They were more interested in the price of oil than the price of interbank borrowing.
This detachment has proved illusory. The nonchalance of the RBI’s staff, for example, is not shared by the central bank’s top brass, who, a day before the strike, cut the bank’s key interest rate from 9% to 8%, having already slashed reserve requirements earlier this month. Their staff’s complaint about pensions looked quaint on the day that Argentina’s government said it would nationalise the country’s private-pension accounts in what looked to some like a raid to help it meet upcoming debt payments. The IMF, which has shed staff this year because of the lack of custom, is now working overtime (see article). The governments of South Korea and Russia have shored up their banking systems. Their foreign-exchange reserves, $240 billion and $542 billion respectively, no longer look excessive. Even China’s economy is slowing more sharply than expected, growing by 9% in the year to the third quarter, its slowest rate in five years.
The emerging markets, which as the table shows enter the crisis from very different positions, are vulnerable to the financial crisis in at least three ways. Their exports of goods and services will suffer as the world economy slows. Their net imports of capital will also falter, forcing countries that live beyond their means to cut spending. And even some countries that live roughly within their means have gross liabilities to the rest of the world that are difficult to roll over. In this third group, the banks are short of dollars even if the country as a whole is not.
-A taxonomy of trouble, Economist
This article makes a compelling argument for expecting emerging markets to be the next leg down in this metastasizing credit crisis. And the Economist devotes much more space to this emerging problem (pun intended).
But, the analysis penned by Ambrose Evans-Pritchard is what really caught my eye. He makes the case for us to worry about a full-scale currency crisis worse than the 1931 currency crisis of the Great Depression. The link: Bank credit. You can think of Sweden in the Baltics, Austria in Central Europe, Spain in Latin America — and you begin to picture the interconnectedness that will imperil Europe’s banking system much more than either Japan’s or America’s.
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