Joined: 16 Dec 2009
|Posted: Sun Dec 22, 2013 9:55 pm Post subject: A Federal Reserve Sponsored Currency Collapse
|I don't know where to put this article. It's not really about American politics as much as the American and world economy. But my bigger interest in it is because of what it suggests for the Canadian economy, and thus, Canadian politics.
|A Fed-Sponsored Currency Collapse
... From Canada to Brazil to Indonesia and even to Australia, currencies around the globe are being crushed by the Federal Reserve.
How? Well, the Fed's expansive monetary policy weakened the [U.S.] dollar and drove down Treasury yields.
In response, a tidal wave of investment capital fled to riskier emerging markets seeking higher returns.
Essentially, the Federal Reserve's reckless spending created bubbles in emerging markets. Now that the central bank is reversing course, those bubbles are starting to pop, one by one...
Morgan Stanley has released a report on what it calls the "Fragile Five" — the five emerging market currencies under the most pressure against the U.S. dollar.
Of course, it's not just emerging markets that are vulnerable.
More developed countries like Canada, Japan, and Australia are vulnerable, as well...
The Fragile Five
Morgan Stanley's Fragile Five include the Indonesian rupiah, the Indian rupee, the South African rand, and the Turkish lira.
With money flying back to the United States, these countries have seen massive outflows of capital that have driven up their borrowing costs and wounded their currencies. [....]
Indeed, when the Fed first turned hawkish back in May, bond yields spiked 430 basis points in Indonesia, 220 points in Turkey, and 120 points in Brazil. President of the World Bank Jim Yong says that's only one-third of the overall increase in interest rates emerging markets are likely to see.
International Monetary Fund managing director Christine Lagarde offered a similar assessment, saying cumulative net flows to emerging markets had risen by $1.1 trillion since the global financial crisis.
According to Lagarde, that's about $470 billion above the long-run structural trend.
The end result:
The Brazilian real is down 14.2% since the start of the year.
Indonesia's rupiah is down about 24%.
The Indian rupee, down 13.5%, hit an all-time low against the dollar in August.
The Turkish lira has hit a record low, as well, having tumbled 17% this year.
And the South African rand is down 21.5%.
Keep in mind it's not only these five currencies that are affected. As I said, developed countries are suffering, too.
When it comes to advanced economies, Canada's loonie is most at risk.
The reason the Canadian dollar is especially sensitive to fluctuations in Fed policy is that the United States and Canada are each other's largest trading partners.
The loonie is already down 7% this year; and any rise in Treasury yields that results from the Fed's decision to taper its monthly bond purchases will further weaken Canada's currency.
Many investment banks believe the loonie will fall to C$1.10 by the end of 2014 from its current C$1.06.
As with emerging markets, money is starting to retreat from Canada, a resource-heavy market vulnerable to spiraling commodities prices.
Remember, commodities are priced in dollars; so as the dollar strengthens, their value falls. That hurts commodities producers like Canada and Australia.
That said, it should come as no surprise that foreigner investors put just $4.5 billion into Canadian stocks in October, down from $10.7 billion in September.
A similar story is unfolding in Australia, which is also resource-rich. The Australian dollar is down about 16% this year, thanks in large part to the dollar's recent bounce.
Indeed, the Australian dollar was worth about $1.03 earlier this year, but now it's worth less than $0.90. Experts believe it could reach $0.85, or even $0.80, in relatively short order.
A New Asian Contagion
And then we have Japan and China.
The dollar jumped to a five-year high against the yen of 104.37 yen after the Fed decision. That threw kerosene on a fire that's burned the yen by more than 20% since the start of the year.
However, it's hard to pin the entirety of that decline on the Fed, since Japan has pursued an expansionary economic policy of its own: "Abenomics," named for Prime Minister Shinzo Abe.
Still, the Fed has had a discernible effect, one that China is feeling it, too.
Just like other world markets, China is vulnerable to capital outflows and yuan depreciation.
In 2012, China's capital outflows totaled $100 billion, or 1.2% of GDP, as the European sovereign debt crisis and a slowdown in economic growth sent worried investors for the exits.
We could be in for a repeat, as a contraction in factory activity already has some observers concerned that China's rebound is losing steam.
Fiat Currency Fails
All of this is to say there's no such good thing as "good money."
We're all familiar with the shortcomings of the dollar. Now you can see just how strong its competitors really are.
As Warren Buffett famously said, "Only when the tide goes out do you discover who's been swimming naked." Well, now you'll get to see vulnerable emerging markets in all their glory. [....]
It suggests the C$ is going down, which could mean higher prices for imports, possibly, along with an improved prospect of exports -- at least to the USA. If all these other nations are also suffering declining currencies, they aren't likely to be calling for imports from Canada.