While world stock markets slump this morning as the Nikkei hits a 26 year low, there is another crisis hitting global markets, the currency crisis:
Loss of confidence, coupled with wild speculation triggered by fear, also roiled currency markets, as investors continued to turn to the American greenback and the Japanese yen, and drove down currency values of many developing countries, including Brazil, Ukraine, South Korea, and even of developed countries like Great Britain, the New York Times reported on Friday.
There were chilling new developments that attested to the wide scope of the world financial crisis, despite efforts by heads of state, central bankers and corporate leaders to stop the market from hemorrhaging. Cash flowed to the dollar and the yen, the two most sought-after “safe havens” in a hurricane ravaged world.
As a result, the currency values of the emerging economies have tumbled. Even the British pound and European euro lost ground in the swirl of storm.
Profit-seeking hedge funds and other investors are pulling money out of the above countries on an immense scale and putting it into dollars and yen. Analysts said that, currently, there existed few safe harbors, as commodities also tumbled.
Fears of a spreading global recession caused oil prices to fall more than 5 percent, to US$64, even after OPEC, the oil cartel, announced it was cutting output.
Economists believe that, when a developing country’s currency loses value rapidly, it impedes its ability to pay back loans and debts, which could cause a rash of corporate or government defaults -- a feature of previous financial crises in Asia in 1997-98 and
Latin America, the New York Times report pointed out.
The cash flight to safety is hurting once-mighty currencies like
’s pound. On Friday, worries about how the financial crisis would affect Britain ’s economy caused the pound to lose 8 cents against the dollar, falling to $1.53. Britain
And the downdraft of the pound and the euro -- which fell to $1.26 against the dollar on Friday, its lowest level in two years -- is less serious for the economic well-being of
Britainand Europe, than the deterioration of currencies like the Mexican peso or the Russian ruble.
Nobel Laureate, Paul Krugman, is also worried about the Mother of all currency crises:
I invented currency crises. No, really — not the thing itself, of course, but I did publish the first paper in the modern academic literature on the subject, back in 1979. And as I like to say, business has been good ever since.
But I never anticipated anything like what’s happening now.
I’ve been reading reports from Stephen Jen, a former student of mine who’s now the chief currency strategist at Morgan Stanley. He points out that since the fall of Lehman, we’ve been seeing clear signs of currency crises throughout the world of emerging markets, including Eastern Europe. This time, it’s not an Asian crisis or a Latin American crisis, it’s a global crisis. He adds,
So far,the US financial sector has been the epicentre of the global crisis. I fear that a hard landing in EM assets and economies will become the second epicentre in the coming months, with very damaging feedback effects on the developed world.
Right now I feel like the guy who was told, “Cheer up — things could be worse!” So he cheered up, and sure enough, things got worse.
Just look at what has happened to the Canadian currency, the "Loonie". Bloomberg reports that the Canada's currency is headed for its worst monthly fall since at least 1950 and the yield on the two- year bond touched the lowest in almost two decades on speculation the economic slump will deepen and oil will decline further:
Finally, please read Edward Harrison's blog entry in Seeking Alpha, Currency Crisis in the Making:
The loonie, as the currency is known because of the aquatic bird on the one-dollar coin, touched the lowest since September 2004. Crude accounted for 10 percent of Canada's export revenue in 2007.
``We're right off the charts in terms of how big this decline is,'' said Doug Porter, deputy chief economist with BMO Capital Markets in Toronto. ``We continue to see tremendous volatility in all financial markets and that's most definitely affecting the currency markets as well.''
Canada's dollar declined as much as 2.9 percent to C$1.2842 per U.S. dollar, from C$1.2472 yesterday, the lowest since Sept. 23, 2004. It traded at C$1.2734 at 2:24 p.m. in Toronto. One Canadian dollar buys 78.53 U.S. cents. The currency is down 7.2 percent since Oct. 17, its fourth straight weekly decline, the longest losing streak in almost a year.
The loonie has dropped 16 percent since Sept. 30, the most in a month since 1950, according to Bloomberg and Bank of Canada data. The Canadian dollar was fixed to the U.S. currency from the founding of the country's central bank in 1939 until after World War II, according to the bank's Web site. It was allowed to float from 1950 until 1962, and then again from June 1970.
``Overnight we've seen the Canadian dollar go from a little burst of strength to incredible and further weakness,'' Porter said. ``The two main drivers here are risk aversion by investors everywhere in the face of what look to be very weak equity markets. But also there seems to be a lack of liquidity in markets which is amplifying the moves we're seeing in all currencies.''
The loonie's second-largest monthly drop was 6.2 percent in November 1976, after Quebec, the country's second-most populous province, elected the separatist Parti Quebecois, ``prompting markets to make a major reassessment of the Canadian dollar's prospects,'' wrote James Powell, author of a book on the history of the currency.
The drop this month is also larger than any annual decline since 1950. The currency fell 9.1 percent in 1992. This year, the loonie has depreciated by more than a fifth.
Crude oil dropped as much as $5.19, or 7.7 percent, to $62.65 a barrel. Crude reached a record $147.27 on July 11. Since then, the loonie has lost 21 percent.
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.Mr. Harrison is right to worry. As South Korea's central bank holds an emergency meeting, the surging yen is ringing alarm bells:
From the Telegraph (Europe on the brink of currency crisis meltdown"):
The financial crisis spreading like wildfire across the former Soviet bloc threatens to set off a second and more dangerous banking crisis in Western Europe, tipping the whole Continent into a fully-fledged economic slump.
Currency pegs are being tested to destruction on the fringes of Europe’s monetary union in a traumatic upheaval that recalls the collapse of the Exchange Rate Mechanism in 1992.
“This is the biggest currency crisis the world has ever seen,” said Neil Mellor, a strategist at Bank of New York Mellon.
Experts fear the mayhem may soon trigger a chain reaction within the eurozone itself. The risk is a surge in capital flight from Austria – the country, as it happens, that set off the global banking collapse of May 1931 when Credit-Anstalt went down – and from a string of Club Med countries that rely on foreign funding to cover huge current account deficits.
The latest data from the Bank for International Settlements shows that Western European banks hold almost all the exposure to the emerging market bubble, now busting with spectacular effect.
They account for three-quarters of the total $4.7 trillion £2.96 trillion) in cross-border bank loans to Eastern Europe, Latin America and emerging Asia extended during the global credit boom – a sum that vastly exceeds the scale of both the US sub-prime and Alt-A debacles.
Europe has already had its first foretaste of what this may mean. Iceland’s demise has left them nursing likely losses of $74bn (£47bn). The Germans have lost $22bn.
Stephen Jen, currency chief at Morgan Stanley, says the emerging market crash is a vastly underestimated risk. It threatens to become “the second epicentre of the global financial crisis”, this time unfolding in Europe rather than America.
Austria’s bank exposure to emerging markets is equal to 85pc of GDP – with a heavy concentration in Hungary, Ukraine, and Serbia – all now queuing up (with Belarus) for rescue packages from the International Monetary Fund.
Exposure is 50pc of GDP for Switzerland, 25pc for Sweden, 24pc for the UK, and 23pc for Spain. The US figure is just 4pc. America is the staid old lady in this drama.
Amazingly, Spanish banks alone have lent $316bn to Latin America, almost twice the lending by all US banks combined ($172bn) to what was once the US backyard. Hence the growing doubts about the health of Spain’s financial system – already under stress from its own property crash – as Argentina spirals towards another default, and Brazil’s currency, bonds and stocks all go into freefall.
Broadly speaking, the US and Japan sat out the emerging market credit boom. The lending spree has been a European play – often using dollar balance sheets, adding another ugly twist as global “deleveraging” causes the dollar to rocket. Nowhere has this been more extreme than in the ex-Soviet bloc.
The region has borrowed $1.6 trillion in dollars, euros, and Swiss francs. A few dare-devil homeowners in Hungary and Latvia took out mortgages in Japanese yen. They have just suffered a 40pc rise in their debt since July. Nobody warned them what happens when the Japanese carry trade goes into brutal reverse, as it does when the cycle turns.
When the markets open today, I expect the crisis in emerging markets to take top priority. Iceland was the first victim of this crisis. The dreadful events there should be a warning to policy makers to address this now or else we could see some awful writedowns at European institutions in the very near future -- not to mention the potential economic destruction this turmoil could cause.
Rapid and volatile trading in currency markets has led to chatter about coordinated government intervention.
If the yen quickly shoots up again versus the dollar and euro -- on Friday it catapulted to a 13-year high against the dollar and nearly a 6½-year high against the euro on the financial markets' fleeting sense of stability -- then monetary authorities may consider a smoothing operation to calm markets and weaken Japan's currency.
So far, central banks have avoided massive intervention in the currency markets, but my hunch is that another round of coordinated intervention is in the pipeline.
Stay tuned, I will be back later tonight.