Sometime back in May 2005, I wrote a similar topic called
The Currency Trilogy Impact of USA Policy on the world Economy and it is timely for a review as RMB has gained much ground to warrant being ranked as one of the major currencies of the world. The economic backdrop and her twin sister; the political struggle has also changed significantly.
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.
While this is happening, fast thinking and creative investment bankers whom are partly if not mostly to be blamed for the economic hardship in 2008 following the demise of Lehman Brothers and CDO market have started to offer products like non-deliverable RMB forward contracts where the settlement is mostly in USD/Euro/Yen. Such products has reached such maturity for Chicago Mercantile Exchange (CMB) being the first exchange globally to offer clearing facilities for such instruments to provide more liquidity, price transparency and reduce counter-party risks which wrecked havoc in 2008 for non-exchange traded products. Various exchanges has also jumped on the band wagon to provide such facilities with Singapore Exchange (SGX) being one of them for Asia Pacific region. Being a Singaporean, instead of being jubilant for Singapore, I felt uneasy as the exchanges will now bear the counter party risks. Let's hope that SGX will be disciplined and shrewd in its conduct of such trades if not God help us all in the next crisis.
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.
The US federal government reached its debt ceiling of USD 14.3 trillion in May 2011 and is likely to face a technical default in August 2011 if the dead lock in Congress in approving an increase in the debt ceiling continues. Surprisingly or not so surprisingly, US federal debt instruments continue to maintain investment grade rating by all 3 rating agencies i.e. Fitch, Moody and S&P. Not known to many, the oligopoly of this industry by these 3 companies is protected by US laws therefore there is bound to be COI as these rating agencies does a delicate balance of maintaining its external reputation and not biting the hands that feeds it.
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.
Both the Euro and the Euro zone seems to be deep in trouble with Greece topping the list at present followed by lesser counter parts like Portugal, Italy, Ireland and Spain nick named (PIIGS). Greece seems to be in locked horns over the populace unwilling to swallow the bitter pre-conditions of ECB/IMF lead rescue package of spending cuts and increase in taxes reasoning that the economy is already in dire straits with high unemployment. Monetizing their debt is not an option if they continue to stay un ECB as only ECB can print money and not the member states who typically finance their deficits by issuing Euro denominated bonds. The differential for CDS on German Bundesbank considered the gold standard in Eurozone now against Greek government bonds have been rising to proportions equating such bonds on par with junk bonds regardless of how the rating agencies peg them. This makes it very expensive for Greece to finance its deficit compounding the problem further.
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.
Perhaps the national anthem for Japan should be changed to "God Saved our Prime Minister" in japanese language of course. Naoto Kan was on the brink of being booted out of office by a no confidence initiative when a devastating earthquake, tsunami and nuclear accident hit Japan on 11th March 2010. The aftermath of both the earthquake and tsunami rebuilding is underway but the nuclear accident is still un-resolved with unpredictable future outcomes as of now. With the nation facing a national calamity, Kan stay in office was temporarily secured as he promises to step down once the situation is more conducive and stable for a power transition. Kan is still in office amidst smaller calls for him to step down. Although Japan is the 3rd largest economy GDP wise, it is drowning in a huge internal fiscal deficit luckily it has a strong external trade balance to buffer it. There are concerns that the disruption in her industrial output could hamper production capabilities of other countries because less forgiving supply chain measured in days instead of weeks or months. It is not uncommon for a product to consists of parts from at least a dozen of countries or more. The re-construction will add to the huge fiscal deficit and the benefit is less likely to be broad-based but more narrowly focused on construction related industries. This could also a cause of worry for the re-emergence of Yakuza power as many construction related companies are infested with Yakuza elements in some way like the post 1972 Kobe earthquake re-construction.
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.
Peter Lye aka
lkypeter
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.
