Nobody is under any illusions as to the gravity of the current situation. The only real question we need to ask now is to what past event we should be comparing the current crisis.
The Financial Times goes some way towards answering that, noting that the last time U.S. Treasury yields were this low was in January 1941 (at the height of the London Blitz during World War II), while the spread between 3-month T-bills and the 3-month LIBOR rose through 3 percent, beating the record hit in 1987 after the stock market crash.
We can add to these measures the quite remarkable fact that 3-month Japanese government paper is now yielding nearly 60 basis points more than the equivalent U.S. paper.
My favorite measure of the severity of our current situation comes from the price movements seen in gold. Having languished below $800 an ounce for most of this month, it suddenly came alive yesterday just as the U.S. stock markets started trading.
Over the course of the next five hours, the price sprinted up by an astonishing $85 (a 10.95 percent increase). To place this in context, this was the largest absolute daily move ever seen in the price of XAU/USD, and the fifth-largest ever in percentage terms.
Given that three of the four greater moves came in January 1980 in the immediate aftermath of Russia's invasion of Afghanistan and during the height of the Iranian hostage crisis, this seems as telling as anything of the scale of the current crisis.
The other telling feature of yesterday's move in XAU/USD was that it showed a marked break with the pattern of how it has traded for months (and, arguably, years).
Through Thursday of last week, the price of gold had been sinking steadily, reflecting the growing expectation that a sharp contraction in levels of global growth would feed through into lower levels of inflation, encouraged by the continued declines in energy prices.
However, despite the fact that oil prices continued to slide until very recently (before spiking slightly higher), the price of gold began to rise steadily. Critically, this move echoed exactly the collapse in U.S. Treasury yields and the astonishing rise in the TED spread (difference in yields between inter-bank and U.S. government loans).
In other words, this had nothing to do with inflation worries, but rather, it was a direct reaction to the rapid deterioration evident in the U.S. banking system as Lehman Brothers began its rapid descent in bankruptcy.
Given this, yesterday's move was entirely consistent with what had been seen over the past week. In light of the torrent of bad news, it was little wonder that U.S. investors decided that a cold, yellow piece of metal was (along with short-dated government paper) just about the most desirable thing to own.
Moreover, although we remain cautious about reading too much into this, we do note that EUR/USD maintained its traditional relationship with gold by sprinting higher in its wake (as did GBP/USD).
Where does this leave the outlook for the forex markets? Some of you know that around two weeks ago I started looking for a dollar correction. Hence, when the USD confirmed the low on Sept. 11 at 1.3882, I'm now comfortable calling for a USD rebound, principally on the argument that it would benefit from repatriation flows as investors exited a wide range of investments overseas.
I'm also wondering how the cascade of events in the U.S. financial industry could impact other places in the world. However, the continued developments over the past few days leave us wondering whether what we are seeing is a more fundamental shift in thinking.
With all the signals indicating that we are now seeing the largest crisis in U.S. markets at least since 1987, there are plenty of reasons to believe that such a fundamental shift might be under way.
With this in mind, I find the comments yesterday from John Chambers, the chairman of Standard & Poor's sovereign ratings committee, unnerving. Speaking to Reuters, he argued that the lack of "pro-active stance" by the United States in its bailout of AIG would have put pressure on the country's AAA rating.
Chambers added: "There's no God-given gift of a AAA rating, and the U.S. has to earn it like everyone else." In other words, without the decision to provide a bridge loan to AIG, there would likely have been a discussion within S&P on the nation's sovereign rating.
With the U.S. sovereign rating seemingly on relatively thin ice and a forced restructuring of the domestic banking system taking place before our eyes, perhaps we should not be that surprised if the next crisis of confidence was in the dollar itself. In those circumstances, adopting a more neutral stance towards the greenback would seem to be warranted.
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