Currency Wars

The last week or so has seen some serious instability in both the Japanese Yen and the Swiss Franc. This instability has the potential to become very serious. In my opinion, the wolves {speculators like Hugh Hendry} are testing these currency's defenses; of late, their defenses have proven to be feeble indeed. Like all carnivores, these wolves will move in where they see a weakness and attack. It's happened before.

In 1992, the Bank of England stubbornly refused to raise interest rates to the European norm or to let it's currency float, resulting in an abnormally strong sterling. George Soros, upon advice of Stan Druckenmiller, shorted approximately $10 billion worth of the GBP on Black Wednesday, September 16th 1992. The Bank of England at first tried to defend it's currency's worth, but at the end of the day they simply got out of the way. Great Britain withdrew it's currency from the EERM (European Exchange Rate Mechanism) and formally devalued the Pound. Soros and his wolves made $1.1 billion on Black Wednesday; the BoE lost over $3.7 billion in this debacle.

It was at this point that the world's Central Banks, aghast at how devastating and profitable it was to attack a currency en masse, banded together in an unwritten agreement never to let this kind of thing happen again and that they would assist one another should such an attack occur again.

This last May the EU banking system, with Greece as the first domino, had a world class crisis on it's hands. Large numbers of people, fearing for the worth of the Euro, began doing what all Europeans have done since the 1800s.. get to the Swiss border and exchange your local currency for Swiss Francs. Today it's a little simpler.. you just call your broker and he does it over the telephone. Still and all, this had the effect of making the Swissy skyrocket in value versus the Euro.. and of sucking the liquidity out of Switzerland itself, resulting in a pretty serious bout of deflation. The Bank of Switzerland, like the Bank of England, fought back valiantly.. later it came out that the Swiss National Bank had lost over $8 billion defending it's currency.. and sadly with the same result.. the market forces were too powerful, and the SNB eventually just got out of the way. Speculators were also a part of this, though it must be said this mini crisis had it's genesis in the Euro Zone's problems and not George Soros. For whatever reason.. probably the same old reason (the European banking catastrophe) Europeans began buying the Swissy again in the last week or so. So far, the SNB has stood by and done nothing. When the SNB threatens action, the Swissy goes down.. but after a day or two of inaction, the wolves crank it back up even further. We are rapidly approaching another Black Wednesday in Switzerland. At this point, after taking a beating last May, the SNB very likely isn't strong enough by itself to curb this. It will need help. Other Central Bankers, Bernanke and Trichet in particular, are nervously watching.. and so far, that's all. Their inaction emboldens the wolves. Today the Swissy hit a record versus the Euro. The silence is deafening.. and dangerous. A nation's currency simply cannot be at the mercy of speculators and scared neighbors, yet here we are. The wolves are pocketing millions and with their profits pile on further.

In Hungary, a good percent of all mortgages are written in Swiss Francs, amounting to half the nation's GDP. The problem is, as the Swissy appreciates, so does the mortgage payments of those Hungarians who took out mortgages in Francs. In January, there were 182 Hungarian Forints for each Swiss Franc; today that figure hit 222.. a better than 22% increase. So the average Hungarian worker, being paid in the local currency {the forint}, must then exchange these Forints for Francs with which to pay their mortgages. Thanks to this, Hungarian and the already vastly overleveraged Swiss banks are taking a nasty hit because of foreclosures. It's consequences like this that make currency games dangerous. Hungary is already in the IMF's doghouse. This is being played out in a number of other Eastern European nations.. with predictably bad results.

Japan's problems have been detailed endlessly here.. way too much debt, Bond rates that are way too low. The Yen keeps appreciating versus other currencies because the way other Central Banks lower rates is to buy their own government's bonds. In Japan, the problem is that their bond rates are already so low that lowering them further would make them essentially zero interest, thus making them completely unattractive to even Japanese investors. Therefore the Bank of Japan has very little power left {after two decades of doing this} to affect the rise in it's currency. Speculators, as ever, dog piled onto Japan's problems and bought the Yen. This week the Bank of Japan announced a small bond purchase.. and because it was so small and feeble, the markets immediately pounced, buying the Yen. It was a very wild ride. In the end, as of this writing, the wolves have succeeded in bidding up the Yen past the day of the intervention, all while Japan's government and central bank look on helplessly.

Bernanke and Trichet are rapidly approaching the River Styx.. at some point, they will be asked by the Swiss, and perhaps even the Japanese, to quietly intervene. I think they'll do it because currency wars like this are dangerous to a nation's economic well being, and this is particularly serious when it comes to Japan, the world's second largest economy. A drastic appreciation in the yen will make Japan's exports uncompetitive, thus worsening their already dire debt and demographic problems.

In a semi related announcement, the IMF today announced that they have extended their FCL (flexible credit line) program and have removed the borrowing cap on this program, which was already quite high, should any nation be in need of rescue. In short, it's their way of expanding their ability to loan in any emergency. Today, in the aforementioned Hungary, the Prime Minister said in an interview that his nation should'nt have to abide by IMF rules, though they are happy to take IMF loans. Only the desperate say such things. It's looking grimmer by the day for the Hungarians.. and their unlucky Swiss bankers.