Tags: euro | area | levy | central bank

Possibility of Another Collapse Isn't Off the Table Yet

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Tuesday, 28 Jan 2014 12:10 PM Current | Bio | Archive

Long-term investors and speculators have witnessed over the last few days that it doesn't take that much to re-accelerate quickly volatility and vulnerability in emerging markets, as well as in developed markets.

What we also have seen is that the emerging economies that have been the most vulnerable are those that have had a substantial expansion of domestic credit during the last five years, deteriorating current account balances, high levels of foreign and short-term debt and over-valued exchange rates.

It must be said, the recent spike in volatility has this time certainly not been caused by the "normalization" process generated by the so-called tapering of the Federal Reserve's bond-buying program, because of the very simple reason we are simply only in its initial and still cautious phase of change in U.S. monetary policy after its prolonged era of historically unprecedented stimulus.

Nevertheless, it's also a fact that practically nobody expects the normalization process will run its full course without causing collateral damage in some places in the world. However, it may be expected the Fed will not be insensitive to these facts as it is very well aware that curbing its historically cheap money policy will not be without risks even in the United States.

Last summer, we saw that only announcing the Fed's initial stages of its unavoidable tightening cycle sparked in some way unnerving and steady depreciation trends in the performance of various currencies of emerging economies.

I think we are poised for growing stress situations in various markets that could occur remarkably at the same time markets will continue to see a Fed committed to normalizing its policy while the world's two most important economic blocs — the euro area and China — will continue to struggle, if not miss, to generate market-friendly growth.

Long-term investors would do well, at least in my opinion, taking seriously what the World Bank's latest Global Economic Prospects January 2014 report stated: "The risk of more abrupt adjustments remains significant, especially if increased market volatility accompanies the actual unwinding of unprecedented central bank interventions . . . abrupt changes in market expectations, resulting in global bond yields increasing by 100 to 200 basis points within a couple of quarters, could lead to a sharp reduction in capital inflows (U.S. dollars flows) to developing countries by between 50 and 80 percent for several months. . . . Some developing countries could face crisis risks should such scenario unfold."

If that were to happen, even only in part, a stronger dollar is in the cards.

I admit such a scenario is still not imminent, yet, but then markets can also not ignore recent concerted currency instability/weakness, which translated into large moves as we have seen in the Turkish Lira, the Chilean Peso and the Argentinean peso in particular.

By the way, Turkey's central bank announced Tuesday it will meet in emergency session and announce its decision on rates at midnight local time (God knows why midnight?). I wouldn't be surprised to see the Turkish central bank raising their overnight interest rate (CBRT), which stands since December 2010 at 1.5 percent, by a whopping 3 to 4 percent. Watch out if the rate hike is less significant because further Turkish Lira weakness could come back with a vengeance.

On China, the "Credit Equals Gold #1" high-yielding investment vehicles that were sold by China Credit Trust Co., one of China's biggest "shadow banks," shows the country's troubles are, in my opinion, only the tip of the colossal iceberg of the opaque and totally un-transparent, and for a great part insolvent, $1.7 trillion Chinese "trust" market.

But now, this time around and after China Credit Trust reached a last-minute deal with its investors to repay their investment, the Chinese trust world hitting a concrete wall seems to have been avoided. The question is how long the Chinese trust industry will be able to continue before we'll see a real washout taking place. Of course, markets can remain irrational for a very long time.

In fact, maybe it's strange, but the Chinese trust problems makes me think somewhat back to the savings and loan (S&L) crisis we experienced in the United States in 1980s and 1990s that saw the failures of about 747 out of the 3,234 S&L associations in the United States. In 1996, the General Accounting Office estimated the total cost of the S&L failures at $370 billion, of which $341 billion was paid for by the U.S. taxpayers. I don't know if Chinese tax payers will be similarly as compliant as their American counterparts were in the 1980s and 1990s.

Finally, after the International Monetary Fund already floated a euro area one-off capital levy idea in October, on Monday, the Bundesbank said in its monthly report that countries in the euro area that at some time in the future would be about to go bankrupt should draw a one-off capital levy on the private wealth within their borders before asking other member states of the euro area for help.

I mention this especially for those investors who have capital interests within the euro area. This is, for now at least, only an official public idea of the most important central bank of the euro area, it should never come as a surprise for the informed investor that the idea of the Bundesbank would be implemented when one day another euro area member state becomes virtually bankrupt.

Please keep in mind that foreigners would not be exempted from the one-off capital levy, as we saw the same thing happen last year under the bail-in rules that were applied in Cyprus, which cost some wealthy Russian investors dearly. Also, such levies were already widely adopted in Europe after World War I and in Germany and Japan after World War II. So, one-off levies are not a new game in town in Europe.

By the way, interestingly the Bundesbank also said in its report it remained concerned about the high debt levels in Greece, Spain, Italy, Portugal, Cyprus, Portugal and Ireland.

Of course, if you are an investor who has capital invested in one of the euro area countries and who is convinced the crisis in the euro area is definitively over, then you don't have to worry about what it could eventually cost you in case we have one or more "replay(s)" from the recent past.

From my side, the possibility of another collapse isn't off the table yet.

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HansParisis
Long-term investors and speculators have witnessed over the last few days that it doesn't take that much to re-accelerate quickly volatility and vulnerability in emerging markets, as well as in developed markets.
euro,area,levy,central bank
1071
2014-10-28
Tuesday, 28 Jan 2014 12:10 PM
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