Europe On The Brink Of Currency Crisis Meltdown

[Methinkshe]

Europe on the brink of currency crisis meltdown

The crisis in Hungary recalls the heady days of the UK’s expulsion from the ERM.

By Ambrose Evans-Pritchard

Last Updated: 9:17PM BST 25 Oct 2008

The financial crisis spreading like wildfire across the former Soviet bloc threatens to set off a second and more dangerous banking crisis in Western Europe, tipping the whole Continent into a fully-fledged economic slump.

Currency pegs are being tested to destruction on the fringes of Europe’s monetary union in a traumatic upheaval that recalls the collapse of the Exchange Rate Mechanism in 1992.

“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.

They account for three-quarters of the total $4.7 trillion £2.96 trillion) in cross-border bank loans to Eastern Europe, Latin America and emerging Asia extended during the global credit boom – a sum that vastly exceeds the scale of both the US sub-prime and Alt-A debacles.

Europe has already had its first foretaste of what this may mean. Iceland’s demise has left them nursing likely losses of $74bn (£47bn). The Germans have lost $22bn.

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.

Broadly speaking, the US and Japan sat out the emerging market credit boom. The lending spree has been a European play – often using dollar balance sheets, adding another ugly twist as global “deleveraging” causes the dollar to rocket. Nowhere has this been more extreme than in the ex-Soviet bloc.

The region has borrowed $1.6 trillion in dollars, euros, and Swiss francs. A few dare-devil homeowners in Hungary and Latvia took out mortgages in Japanese yen. They have just suffered a 40pc rise in their debt since July. Nobody warned them what happens when the Japanese carry trade goes into brutal reverse, as it does when the cycle turns.

The IMF’s experts drafted a report two years ago – Asia 1996 and Eastern Europe 2006 – Déjà vu all over again? – warning that the region exhibited the most dangerous excesses in the world.

Inexplicably, the text was never published, though underground copies circulated. Little was done to cool credit growth, or to halt the fatal reliance on foreign capital. Last week, the silent authors had their moment of vindication as Eastern Europe went haywire.

Hungary stunned the markets by raising rates 3pc to 11.5pc in a last-ditch attempt to defend the forint’s currency peg in the ERM.

It is just blood in the water for hedge funds sharks, eyeing a long line of currency kills. “The economy is not strong enough to take it, so you know it is unsustainable,” said Simon Derrick, currency strategist at the Bank of New York Mellon.

Romania raised its overnight lending to 900pc to stem capital flight, recalling the near-crazed gestures by Scandinavia’s central banks in the final days of the 1992 ERM crisis – political moves that turned the Nordic banking crisis into a disaster.

Russia too is in the eye of the storm, despite its energy wealth – or because of it. The cost of insuring Russian sovereign debt through credit default swaps (CDS) surged to 1,200 basis points last week, higher than Iceland’s debt before Götterdammerung struck Reykjavik.

The markets no longer believe that the spending structure of the Russian state is viable as oil threatens to plunge below $60 a barrel. The foreign debt of the oligarchs ($530bn) has surpassed the country’s foreign reserves. Some $47bn has to be repaid over the next two months.

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.

A grain of comfort for British readers: UK banks have almost no exposure to the ex-Communist bloc, except in Poland – one of the less vulnerable states.

The threat to Britain lies in emerging Asia, where banks have lent $329bn, almost as much as the Americans and Japanese combined. Whether you realise it or not, your pension fund is sunk in Vietnamese bonds and loans to Indian steel magnates. Didn’t they tell you?

[GregG]

This is scary stuff, so the question to ask is where is safe.

What country is not exposed and has an economy best placed to weather a severe downturn.

New Zealand perhaps. No chance of them being involved in a war and primarily an agricultural economy. 2.5 billion Asians have to eat something, however bad things get.

[frozen_out]

Don't know what to say to that.

It's not contained is it?

[Methinkshe]

This is scary stuff, so the question to ask is where is safe.

What country is not exposed and has an economy best placed to weather a severe downturn.

New Zealand perhaps. No chance of them being involved in a war and primarily an agricultural economy. 2.5 billion Asians have to eat something, however bad things get.

It's this kind of thing that I find scary:

It is just blood in the water for hedge funds sharks, eyeing a long line of currency kills. “The economy is not strong enough to take it, so you know it is unsustainable,” said Simon Derrick, currency strategist at the Bank of New York Mellon.

Once the hedge funds smell blood they won't stop until they've done what George Soros did to sterling in the ERM crisis. It'll be one-way bets all the way down. Any sign of weakness makes for a self-fulfilling prophecy.

Btw, what is the point of hedge funds in terms of usefulness to the real economy? Or is their whole raison d'etre speculation/gambling? Are they 100% parasitical, in other words, or do they actually perform any useful function?

[Bardon]

I love the author never a dull article from such a sincere person.

[IMHAL]

It's this kind of thing that I find scary:

Once the hedge funds smell blood they won't stop until they've done what George Soros did to sterling in the ERM crisis. It'll be one-way bets all the way down. Any sign of weakness makes for a self-fulfilling prophecy.

Btw, what is the point of hedge funds in terms of usefulness to the real economy? Or is their whole raison d'etre speculation/gambling? Are they 100% parasitical, in other words, or do they actually perform any useful function?

Do they perform any useful function? I guess you could say that they are the combined hunters and vultures of this world - they takes the weakest and eats them up. Those that are still living then need to stay healthy or they face becoming victims - it must be a very good incentive to keep a good balance sheet.

[Paddles]

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.

Really how safe is Santander and half of our "rescued" banks and buildos?

[Deckard]

It's this kind of thing that I find scary:

Once the hedge funds smell blood they won't stop until they've done what George Soros did to sterling in the ERM crisis. It'll be one-way bets all the way down. Any sign of weakness makes for a self-fulfilling prophecy.

Btw, what is the point of hedge funds in terms of usefulness to the real economy? Or is their whole raison d'etre speculation/gambling? Are they 100% parasitical, in other words, or do they actually perform any useful function?

HFs are going through a very rough patch, due to massive redemptions and higher finance/borrowing costs. The head of Citadel reckons 30% of HFs will not survive the present crisis (see relevant thread a couple of days ago).

However, the combined strenght of the still healthy HFs is enormous, and they could easily send EM currencies into a tailspin.

The fact that US HFs are getting out of EM stocks and buying US assets is the single main factor behind the recent $ appreciation.

Whether or not HFs perform a useful function has been the subject of endless discussions for decades. Personally, I think they are a bunch of sharks who wouldn't think twice to ruin a country's economy in exchange for a short term profit. I guess in a free market you cannot stop audacious investors from targeting this kind of opportunity - but regulation needs to be seriously tightened and leverage monitored.

The current ban on short sale of financial stocks is a joke, and just goes to show how little the SEC, FSA etc understand about derivatives in general and the way HFs build synthetic positions in particular.

Edited October 26, 2008 by VoteWithYourFeet

[mdman]

I love the author never a dull article from such a sincere person.

+1

AEP started my 'financial Armageddon' schooling last year with some articles from August 2007 onwards including this.

Got into this site, and all the other doomster economists soon after. Cheers AEP

[Paddles]

HFs are going through a very rough patch, due to massive redemptions and higher finance/borrowing costs. The head of Citadel reckons 30% of HF will not survive the present crisis (see relevant thread a couple of days ago).

Call me simple, but I struggle to understand how hedge funds can be in trouble; surely the clue is in the name. Aren't they supposed to be smart enough to offset potential losses on one investment with oppositely-aligned investments?

[19 year mortgage 8itch]

I love the author never a dull article from such a sincere person.

Ambrose really only sings one tune doesn't he?

[Deckard]

Call me simple, but I struggle to understand how hedge funds can be in trouble; surely the clue is in the name. Aren't they supposed to be smart enough to offset potential losses on one investment with oppositely-aligned investments?

This is a good explanation of the problems they are facing:

http://www.bloomberg.com/apps/news?pid=206...&refer=home

[Bardon]

+1

AEP started my 'financial Armageddon' schooling last year with some articles from August 2007 onwards including this.

Got into this site, and all the other doomster economists soon after. Cheers AEP

You wouldn't want to be one of his targets as Bill found out.

The Hollinger Corp, the media cartel that grew out of World War II British intelligence operations aimed at the United States, dispatched, in 1993, under journalist cover, a self-admitted MI6 stringer, Ambrose Evans-Pritchard, to stir up a seemingly endless string of sex and murder scandals, all aimed against the President. Evans-Pritchard has bragged, in the pages of the Telegraph newspapers, that he personally induced Paula Jones to launch her legal suit against President Clinton. The suit has been bankrolled, from day one, through various right-wing and Christian fundamentalist fronts, all financed by Richard Mellon Scaife, the scion of the rabidly Anglophile Mellon family

[bajista]

Ambrose really only sings one tune doesn't he?

Yes. I love the way he uses the failings of all the non-Euro countries ( UK, switz, sweden) to make his weekly Euro-bash sound like he has never written it before. Did a German steal his girlfriend or boyfriend maybe?

I suppose following his sort of logic, the huge economic differential between Canada and Mexico must completely annihilate the US economy for ever!

[ParticleMan]

Call me simple, but I struggle to understand how hedge funds can be in trouble; surely the clue is in the name. Aren't they supposed to be smart enough to offset potential losses on one investment with oppositely-aligned investments?

"Hedge" fund these days is more a euphamism for algorithmic traders with no specific investment strategy in mind (or for that matter in the prospectus) beyond "leverage it up to the eyeballs" and "be right by virtue of arriving first" (and perhaps "risk management? waste of money son, why would you want that?").

In other words, an amplification vector for the witless and clueless retail clients that ultimately capitalise them (either directly, or indirectly via equally suspect intellects over in the investment banking world that lend them risk capital and creditworthiness guarantees).

If you seed the system with "leverage will extend proportionate with nominal size of the system" the only "losing" strategy merely retains less of the system in real terms (or in hedge fund terms, the only losing fund strategy merely succeeds in manufacturing less "profit").

Pick the obvious flaw here.

... so the pendulum swings back...

On the bright side if a fund's prospectus is essentially selling greed to the fearful it's hard to succeed in claiming, later (when the wheels inevitably fall off) that you were mis-sold.

These guys are all going to suffocate because none of them generate sufficient yield on their existing assets.

And it's going to be a while before people think about giving them any new capital to play with.

Edited October 26, 2008 by ParticleMan

[Methinkshe]

Yes. I love the way he uses the failings of all the non-Euro countries ( UK, switz, sweden) to make his weekly Euro-bash sound like he has never written it before. Did a German steal his girlfriend or boyfriend maybe?

I suppose following his sort of logic, the huge economic differential between Canada and Mexico must completely annihilate the US economy for ever!

If more people had listened to AEP earlier this year (Feb, March) when he was banging on about the danger of Icelandic Banks, and the threat to the Icelandic economy, fewer would have lost money in Icesave et al. One trick pony, he is not.

[ParticleMan]

If more people had listened to AEP earlier this year (Feb, March) when he was banging on about the danger of Icelandic Banks, and the threat to the Icelandic economy, fewer would have lost money in Icesave et al. One trick pony, he is not.

I just can't seem to read Pilchard's columns without mentally superimposing them over a Flanders and Swann sketch.

The English are moral, the English are good

And clever and modest and misunderstood.

And all the world over, each nation's the same

They've simply no notion of playing the game

They argue with umpires, they cheer when they've won

And they practice beforehand which ruins the fun!

The English, the English, the English are best

So up with the English and down with the rest.

[Guest Mr Parry]

This is scary stuff, so the question to ask is where is safe.

What country is not exposed and has an economy best placed to weather a severe downturn.

New Zealand perhaps. No chance of them being involved in a war and primarily an agricultural economy. 2.5 billion Asians have to eat something, however bad things get.

http://www.thaivisa.com/forum/Thailand-Esc...wn-t219231.html

I do not believe this though.

[the end is a bit nigher]

Hedge funds are there to provide absolute returns. Normal funds work on the basis of relative returns i.e. if the market loses 50% but a fund only loses 45% then the fund has outperformed the market. THis is great except investors have still lost 45% of their money. Hedge funds should make money for investors regardless of market conditions, hence all the shorting they undertake.

[expatowner]

I had a "shoe-shine boy" moment yesterday.

A friend told me he is making more by trading currencies in the evenings than his day-time job gives him.

He was sounding me out A) if I wanted him to gamble with my money too and what did I think of him giving up his job to trade full-time.

He works in a fairly recession proof industry - Quality Control work on multi-million dollar boats.

I mumbled my decline on investment and told him he has a good job he shouldnt give up.

Oh this is all going to end in tears!

[ParticleMan]

Hedge funds are there to provide absolute returns. Normal funds work on the basis of relative returns i.e. if the market loses 50% but a fund only loses 45% then the fund has outperformed the market. THis is great except investors have still lost 45% of their money. Hedge funds should make money for investors regardless of market conditions, hence all the shorting they undertake.

That's the balls that the (second? third) round of funds put in their marketing bumpf.

Sounds good.

Starve it of fresh capital though and it goes out with a whimper - and the halcyon days of continuous recapitalisation to an impossibly ever-growing nominal is gone.

The stark new reality is that each round of capital raising will source less capital than was destroyed prior.

In systemic terms, generating a dividend yield from assets under management which is actually below frictional costs is going to rise to the fore.

And none of these guys are equipped to deal.

Edited October 26, 2008 by ParticleMan

[stormymonday_2011]

Call me simple, but I struggle to understand how hedge funds can be in trouble; surely the clue is in the name. Aren't they supposed to be smart enough to offset potential losses on one investment with oppositely-aligned investments?

They have a small problem with leverage.

Also as this crisis unfolds they will find that governments tighten regulation of markets, tighten credit limits and ultimately be forced to put in place exchange controls. The latter two processes will mean death to most hedge funds. As the FX markets unravel they could well enjoy a second 'Happy Time' like German U boats did when the US entered the Second World War in late 1941-1942. Ultimately, like the submariners most HF and their crews will end up sunk in Davy Jones locker.

[ParticleMan]

I had a "shoe-shine boy" moment yesterday.

:

Oh this is all going to end in tears!

Heh.

In other words he's shot right through some no-brainer momentum trades (fundamentally placing trades against the current market's ultimate patsy) and he's looking for additional leverage to increase return.

Stay well clear.

Or see if you can persuade him to at least limit capital at risk in line with his own, non-borrowed reserve (althought you probably won't be able to, until he loses his shirt and the shirts of everyone else standing within a ten mile radius).

Leveraged forex offers virtually unlimited downside. Unless other people are happy to trade a currency you happen to print.

[Uriah Heap]

Heh.

In other words he's shot right through some no-brainer momentum trades (fundamentally placing trades against the current market's ultimate patsy) and he's looking for additional leverage to increase return.

Stay well clear.

Or see if you can persuade him to at least limit capital at risk in line with his own, non-borrowed reserve (althought you probably won't be able to, until he loses his shirt and the shirts of everyone else standing within a ten mile radius).

Leveraged forex offers virtually unlimited downside. Unless other people are happy to trade a currency you happen to print.

I had a play on one of those websites - you can set up a game account where you don't use real money. As soon as I got the hang of it I managed to make some substantial gains on my first couple of sessions. Lost the lot and then some on the third one. I will confess that I did have a slight feeling of elation between session two and session three. I wondered if I had in fact found a magic money machine. I am a naturally cautious person but even so I can imagine myself getting carried away with it quite easily. There are plenty of rationalisations you can come up with as to why you should be able to consistently beat the market. The ones I came up with are:-

- I am of above average intelligence based on my qualifications

- I am a scientist so I am particularly numerate

- Big companies make a profit in this area so why shouldn't I

- I have spent a lot of time reading financial news so I have acquired an instinct for it

- I am naturally cautious so I can take risks without them coming unstuck, because I am naturally cautious

I bet everyone on this site can come up with a similar list. I would really like to believe that list. However, on my third session I managed to lose a packet despite all these apparent advantages.

As you say, shoe shine moment.......

Edited October 26, 2008 by Uriah Heap

[porca misèria]

A friend told me he is making more by trading currencies in the evenings than his day-time job gives him.

Hey, I've made a lot of money on currency recently (by virtue of holding three foreign ones - purely for historic reasons of not having converted them to £). Shall I give up the day job?