Opinion: Currency mayhem
3rd Nov 08, 8:55am
The Yen and the US dollar's recent joint appreciation have created more global instability. The Nikkei has lost 33% as the strengthening yen weakens export earnings. The G7 group emphasized the yen's "excessive gains" and hinted at the need for concerted international action to curb this destabilizing tendency. Do not expect instant action: who is going to sell yen to buy sterling? Lex's Financial Times column says Japan's reward for largely avoiding the credit bubble is a soaring currency - up 15% against the $US since July. I believe that deeper forces are involved. The most immediate is the collapse of the carry trade, followed by the flow of capital out of stock markets, hedge funds and deposits into prime bonds in Japan, Europe and the US. The unwinding carry trade The Australian dollar has fallen rapidly. I thought first, the fall was related to the sell off of BHP etc, before realizing that massive amounts of foreign currency had been invested in Aussie dollar-denominated assets which are now deleveraging. According to JPMorgan data, the Australian dollar has lost 55.03% against the USD in six months. The Kiwi, another carry trade destination, has lost 41.8% in the last six months. When other countries in the region are analyzed, Papua New Guinea rose against the US. Indonesia, Singapore, Taiwan and Thailand lost only about 10%, presumably because they were uninvolved in the carry trade. Another aspect of this phenomenon is that the "commodity currencies"- Australia, New Zealand, Canada and South Africa have all plunged as the heat goes out of the commodity market. South Africa is down 43% and Canada 25% in the half year. The carry trade argument is strengthened by the fact that other major currencies, strong enough to have a "reserve role", have also declined relative to the US and Japan. The US dollar and the yen were carry trade vehicles due to their low interest rates and weakening price trends until the credit crisis flourished. Thus the Euro has lost 23% and the pound 24% against the dollar in the last six months. Deepening credit crisis The dollar and yen have strengthened amazingly in the last month through repatriation and "refugees" from both developed and undeveloped markets. While investors previously held a wide range of assets, they are now pouring money into bonds rather than stocks, property, futures and hedge funds. Bonds are a safe haven where investors find refuge from the typhoons besetting the global economy. Those investors who have moored their portfolios safely will be pleased that their prudence has been rewarded. Elsewhere there have been massive share market, commodity price and exchange rate falls. October 2008 will go down as the worst month in financial history. At the end of September, many investors felt a floor was being formed. Markets have edged since then towards capitulation. This year so far has seen huge losses in the major stock markets: Wall Street and the Footsie are down about 40%, Europe and Australia about 45%, while stocks are more that 50% down in Japan, Korea, and Hong Kong. Some developing markets have been put to the sword: Russia is down 73%, India 57%, China 65% and Brazil 50%. Recovery is unlikely until better earnings data appears. The lack of other investments indicates the value of the yen and dollar shelters. Obviously the Yen and dollar are the beneficiaries of declining confidence in emerging markets. Their stock markets have been hammered and currencies plunged in value. In Latin America, the Brazilian currency has lost 38% in six months against the USD: Mexico 27%, and Chile 50%. India has also lost about 27% Europe and current account deficits Britain and Europe are not safe havens because of their exposure to emerging markets and countries with large current account deficits (CADs). States like New Zealand have previously had no discernible difficulty in funding CADs as high as 8% of GDP. They are now struggling. The latest Bank of International Settlement data reveals that European banks hold about three-quarters of emerging market private sector debt through loans to Eastern Europe, Latin America, and Emerging Asia. They may have lost $US 75 bln in the Iceland debacle for starters. The exposure is as silly as US banks exposure to subprime. Austria lent the equivalent of 85% of its GDP to Hungary, Ukraine and Serbia - all now pleading for additional loans from the IMF. Switzerland's exposure is 50% of GDP, Sweden's is 25%, and the UK's is 24%. Contrast this with the canny US which lent only 4% of GDP. Latin America is the US's backyard, but it lent little there, but the proud Spanish lent twice as much, and are threatened by another Argentinean default. Eastern European counties are desperate for capital. Hungary has raised rates to 11.5%, Romania has overnight rates of 900% to stop capital leaving, and Russian debt attracts credit default swap rates of 1,200 basic points: a sure sign the market feels Russia will not be solvent if oil fall further in price. Japan's problems The rising yen dismays Tokyo. Japan's export-led growth strategy is based on a weak yen. A surging yen has helped to halve its cars exports this year. That has set off a deleterious chain reaction. Falling export earnings caused the Nikkei to fall, and this spelt disaster for Japanese banks which are very different to US or UK banks: they do not hold mortgage assets, but prefer to hold shares (currently $US 250 bln), especially those of an affiliated group of companies (zaibatsu like Mitsui, Mitsubishi or Sumitomo). When the share market falls the bank's assets are squeezed, and their capital ratios come into question. The Japanese Government is bailing the banks out of their paper losses as well as promoting emergency tax cuts. As interest rates are presently near zero, there is no room for interest rate cuts to deter investors from holding the yen. The Government is almost a powerless by-stander in a situation of on-going destruction. *Neville Bennett is a long-time Senior Lecturer in History at the University of Canterbury, where he has taught since 1971. His focus is economic history and markets. He is also a columnist for the NBR where a version of this item first appeared.