Technically, there are only 3 main currencies for international trade and reserve purpose because the RMB is non deliverable outside China due to exchange controls imposed by China. This is fast changing as China is experimenting on a limited scale in denominating both import and export in RMB. There is much controversy within China that it might in fact worsen the currency imbalance much like some patients dying from the chemotherapy treatment for their cancer instead.
In addition, a number of Chinese Banks with overseas branches have started offering deposit taking accounts denominated in RMB. The catch is that they are both non-interest bearing and acceptance and delivery is not in RMB but usually the home currency of the branch or USD. Customers are attracted by the money making possibilities based upon the upward trajectory of the RMB.
In today's complex web of financial derivatives, the impact of a technical default of US Federal Government will be further ashore than USA and beyond the holders of the bonds unlike similar circumstances when US defaulted on its bond sold in london by George Peabody of JP Morgan in 1800. Some instruments or products can vaporize into zero value if they have a Credit Event clause tied to the US Federal Government embedded within. Many of these instruments are likely to be traded off exchange and it might take longer for such defaults to become visible. There is also the domino effect of such systemic failures to contend with. All things considered, it is likely to be a larger fire ball compared to Lehman Brothers.
Since the probability of such Credit Events happening is deemed as highly unlikely, correct risk pricing becomes more complicated normally resulting in a bipolar price situation of swinging between extremes at very short notice. This could wipe out products or instruments deemed as safe haven to reach cynaide grade toxicity in a blink of an eyelid. Post Lehman Brothers, only the shorter termed instruments would have expired or re-termed on better conditions but the longer termed instruments continue unabated in carrying such risks. Another class of assets that are likely to be at risk are issuers Credit Default Swaps (CDS). Go check the definition of Credit Events in www.isda.org which is frequently referenced and used and you will be surprised by how wide and easily invokable the definition is.
With the US presidential election due in 2012 and Obama playing his cards towards a second term presidency, he is likely to go for temporal pain relief type of measures than hard to swallow bitter medicine to garner more votes. Surprisingly, his own Democrats in Congress are calling for a more difficult double barreled measure of spending cuts and increasing taxes while the Republicans are only calling for spending cuts.
Should the inevitable but not impossible event happens that Greece gets out of the ECB, the whole un-winding process back to their own currency is likely to be 10 times more complicated, painful and long drawn than when Greece entered the ECB. Firstly, valuation wise, the formulation, basis would be so wide ranging and controversial that market sentiments will likely rule the day. Perhaps break fuse would be enforced to prevent sudden unprecedented drop but such relief is only temporal and finally, the market still dictates its valuation. Secondly, with little or no bilateral or multilateral currency swaps agreement with partner countries, the new currencies is wide open and naked to predatory practices of short term market speculators. ECB is most likely to be provide this air-cover as part of the agreement but it is likely to be only effective for short to medium term as the politicians behind the ECB are likely to loose voter support especially in Germany and France. As the ECB is an economic and monetary union with each member state preserving their own political sovereignty, the election time table is on a staggered time line unlike in USA and this would buy the ECB some more time albeit a small measure.
If history can be relied upon to repeat itself, we could most probably rest more easily about Japan and Europe as most world-wide recessions in recent past have their roots mainly in US save I think for the Asian and Latin American economic crisis.
Of bigger concern is the forth-coming shift in economic and military power. Of the USD 14.3 Trillion debt, about USD 1.3 Trillion is held by China. In addition, China is also a major holder of Euro zone government bonds. These were the results of trade surpluses accumulated by China. It is almost a no brainer that if the current growth and decline continues with China and USA, China's GDP will surpass that of USA in about 2020. On a per capita basis, pro-literate camps in USA argue that USA still reign supreme on a per capita basis and this is what counts most. The flip side to this 'per capita' argument will also mean that China's GDP has far more growth potential to tap on as development continues in the 2nd, 3rd, 4th and subsequent tiers of urban areas. My parting worry is that shifts in economic power rarely goes on peacefully and could result sew the seeds for another potential world war yet again.
Safe Harbor
Please note that information contained in these pages are of a personal nature and does not necessarily reflect that of any companies, organizations or individuals. In addition, some of these opinions are of a forward looking nature. Lastly the facts and opinions contained in these pages might not have been verified for correctness, so please use with caution. Happy Reading. Copyrights of all contents in this blog belongs to Peter Lye unless stated otherwise.
