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Monday, October 27, 2008


the emerging market crisis

following on -- the telegraph's ambrose evans-pritchard reports on the possibility of a eurozone crisis stemming from the collapse of eastern european emerging markets.

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. ...

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. ...

Traders are paying close attention as contagion moves from the periphery of the eurozone into the core. They are tracking the yield spreads between Italian and German 10-year bonds, the stress barometer of monetary union.

The spreads reached a post-EMU high of 93 last week. Nobody knows where the snapping point is, but anything above 100 would be viewed as a red alarm. The market took careful note on Friday that Portugal’s biggest banks, Millenium, BPI, and Banco Espirito Santo are preparing to take up the state’s emergency credit guarantees.

Hans Redeker, currency chief at BNP Paribas, says there is an imminent danger that East Europe’s currency pegs will be smashed unless the EU authorities wake up to the full gravity of the threat, and that in turn will trigger a dangerous crisis for EMU itself.

“The system is paralysed, and it is starting to look like Black Wednesday in 1992. I’m afraid this is going to have a very deflationary effect on the economy of Western Europe. It is almost guaranteed that euroland money supply is about to implode,” he said.

more via yves smith from ed harrison of credit writedowns. more still from paul krugman (and more). the unwind of the carry trade and resulting emerging market currency crisis is also this week's cover story for the economist.

this has gone in a week's time from being a sideshow to the main event. ken rogoff and carmen reinhart called early on to watch for sovereign defaults, as they are chronically characteristic of large financial crises. now we are getting them -- see the chart of PCY -- iceland and argentina being perhaps just the first of a string that could result in a titanic monetary and economic collapse which might well propel the global economy into something entirely more awful than a recession. here is rogoff in the ft this morning:

Ken Rogoff, former chief economist at the IMF, highlights the connection between commodities and sovereign debt crises. He tells FT Alphaville (our emphasis):

Even a normal global recession would surely have triggered a rash of sovereign debt crises (not necessarily defaults if they are bailout out). Falling commodity prices and tighter global credit conditions have been leading indicators of sovereign debt crises for two centuries (as Carmen Reinhart and I show in charts in our “Panorama paper”). What is happening now goes beyond that, the financial panic that was centered in Europe and the US up until a couple of weeks ago has fanned out into emerging markets, particularly those with large current deficits and significant financing needs (the latter generally being due to corporate rather than public debt.)

If history teaches us anything therefore, the current sell-off in commodities from all-time inflation-adjusted highs just this summer will undoubtedly lead to a bout of sovereign defaults.

moreover -- note the position of switzerland in the crisis -- "Exposure is 50pc of GDP for Switzerland". the swiss franc (and particularly swiss banking) may not be the bastion of safety i would have thought. switzerland may very well not have the ability to prevent the kind of bank collapses that could result from a full manifestation of this crisis.

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damn, everything's a moving target like never before. you caught me right before i bought a plane ticket to switzerland. (kidding on the latter.)

i still like the idea of (at least) a "disaster insurance" play in foreign currency.

now if something would just sit still.

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lol -- hell of a close today, dc -- (-3%) in the final ten minutes! i wonder whose margin call that was...

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i was wondering if you'd comment on this little cliff-diving-last-10-minute-action ditty.

3%? pshaw - mere pocket change for the hedge funds!

think the runoff will pick back up at the opening bell?

waking up tomorrow looks to be easy.

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from perrone: hey GM, remember when I said yen instead of swiss francs?

I'll tell you what, I like my "Good Man Is Hard to Find" analogy more and more. we're all being taken out to the woods.

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you did call it, perrone -- dead right, seems to me. though who the hell knows what the next turn of this thing will be!

i'm really surprised by the intensity of the positive dollar move as well, considering the government promises being handed out. it may be fleeting, but it has been strong.

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