Is This How the Next Global Financial Meltdown Will Unfold?

I have long maintained that the structural imbalances of debt and risk that triggered the Global Financial Meltdown of 2008-2009 have effectively been transferred to the foreign exchange (FX) markets.

This creates a problem for the central banks that have orchestrated the “recovery” by goosing asset bubbles in stocks, real estate and bonds: unlike these markets, the currency-FX market is too big for even the Federal Reserve to manipulate for long.

The FX market trades roughly the entire Fed balance sheet of $4.5 trillion every day or two.

Currencies are in the midst of multi-year revaluations that will destabilize the tottering towers of debt, leverage and risk that have propped up global growth since 2009.

Though the relative value of currencies is discovered in the global FX market, there are four fundamental factors that influence the value of any currency:

1. Capital flows into and out of the currency (and the nation that issues the currency).

2. Perceived risk, specifically, will this currency preserve my global purchasing power (i.e. capital) or erode it?

3. The yield or interest rate paid on bonds denominated in this currency.

4. The scarcity or over-abundance of the currency.

If we dig even deeper, we find that currencies reflect the income streams and assets of the issuing nation. Consider the currency of an oil exporting nation that has seen both its income from selling oil and the underlying value of its oil in the ground fall by more than 50%.

Why shouldn’t that nation’s currency decline in parallel with the erosion of income and asset valuation? As a nation’s income and asset base decline, there is less national income to pay interest on sovereign bonds, less private income to tax, and a reduced asset base for additional borrowing.

This is especially true if the nation issued debt and/or currency profligately in good times. Recall that debt and currency are one in the same: if someone trades euros for a U.S. Treasury bond, they don’t just own a bit of sovereign debt–they own the currency of the nation that issued the bond (in this case, the U.S. dollar).

This is equally true of corporate bonds–all the debt is denominated in a specific currency, and owners of the bonds are not just betting that the interest will be paid and the bond redeemed at maturity, but that the underlying currency will not lose much of its global purchasing power.

One proxy for the absolute destruction of commodity-based income streams and assets is the CRB Index. No wonder emerging economies that depend heavily on the export of commodities are cratering, along with the currencies they issue.

Once participants become aware of the rising risk of holding a depreciating currency, the trickle out of a currency quickly becomes a torrent of fleeing capital.

Once the perceived risk switches from risk-on to risk-off, the only way to prop up the currency is to raise the interest rates that bonds denominated in that currency yield.

But raising interest rates has a brutally negative effect on the domestic economy, as higher rates choke off domestic lending, which then pushes the economy into recession.

It’s a no-win double bind, though, for doing nothing and letting one’s currency implode drains the nation of capital and makes imports unaffordable. That matters when the imports are energy and/or food.

When those become scarce and unaffordable, social disorder soon follows.

The currency that has benefited from this reversal of capital flows is the U.S. dollar (USD):

Debt/currency crises tend to trigger defaults and weakness in other currencies.We have a recent example of such a crisis: the Asian Contagion of 1997-98:

Though that crisis was linked to Thailand’s failed bid to support its currency’s peg to the U.S. dollar, the current situation is actually far more fragile as the destruction of commodity income and valuation raises the risk of sovereign defaults, corporate bond defaults, and capital flight that deepens already severe emerging-market recessions.

The bone-dry half-dead forest awaiting an igniting lightning strike is the global mountain of debt–debt which is no longer supported by current valuations of commodities and risk.

In effect, a currency crisis is simply the abrupt revaluation of the currency to reflect new realities. That revaluation then raises the risk premium on debt denominated in that currency or owed in other currencies.

As emerging market currencies decline, the income streams needed to service all the debt denominated in U.S. dollars declines, a self-reinforcing dynamic: as income and valuations fall, capital flees, pushing the relative value of the currency down even more, which further raises the risk premium that then triggers even more capital flight.

The sums in play are so staggering (an estimated $11 trillion in emerging market debts denominated in other currencies) that even the Fed won’t be able to stop the meltdown.

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  • Oranges & Lemons

    People as uninformed and as gullible as Americans have no future. Americans are a dead people that history is about to run over – Dr. Paul Craig Roberts

    While the brute and ignorant masses in America are distracted with the recent “ISIS terrorist attacks” that took in place in Paris (in reality a false flag operation courtesy of CIA + MI6 + Mossad + DGSE), few of them are able to grasp the implications of China’s Yuan becoming the next reserve currency.

    In fact, guns, ammo, gold or silver won’t do any good for those who believe that they will be able to cope with the impeding economic chaos coming to America, and worst of all, challenging the Sovereign –the Federal Government– will be the less desirable thing to do under these extreme circumstances (unfortunately, hundreds of thousands if not millions will foolishly perish as a result of their stupidity, ignorance and gullibility).

    Once China’s Yuan becomes a reserve currency –official announcement to be made by the International Monetary Fund this coming Monday, November 30th, 2015– anything will be the same in the United States as you know it. As a result of the IMF disclosure, ordinary Americans will finally learn the meaning of living within their means (a painful but needed lesson for most of the populace)…the progressive loss of purchasing power using US Dollars is going to hurt badly everyone in this country, it is unavoidable and that event will be labelled as the real SHTF.

    This blog seems to deliberately ignoring the tectonic shift that will take place in the financial world in less than 9 days.

  • Gordon Barlow

    No disrespect here, George, but I’m not sure the advent of the Chinese currency will have much *immediate* effect. A Chinese fiat unit is another fiat unit. A kiss is just a kiss, on that you can rely. I am probably being a wee bit simple-minded about this, but here are my thoughts on the topic…

    • Grateful Dead Person

      Thanks for your voice of reason Gordon.
      Did PaulCR renounce his citizenship in a fit
      of anger?…or is he describing himself?
      What happened to his normally helpful well
      informed directions?

      Collapsing in the road and getting run over is
      not in the basket of options for we the people.

      Gordon,Please consider supporting [D] HI Tulsi Gabbard’s
      House Resolution to stop the war.
      Would you support her becoming a presidential
      We the people ARE experiencing a crisis of governance
      so please share your emergency -directive priority- list
      as if you were the president elect with NSA and cabinet
      advisers at your side ready for executive orders.

      Let us use the internet communication ‘miracle’ to formulate
      functional policy to alleviate conflicting pressures on the
      commander in chief.

      Hoping for your spare change at this beggar’s banquet

      • Gordon Barlow

        Sorry, GDP, but I’m not a US citizen – or even a resident. As you’ll see from my blog, for the past 37 years I have lived in a British colony in the Caribbean. I do take a keen interest in what the US Empire gets up to around the world, but all I can do is use my blog to warn my readers about the threats to civilisation posed by the out-of-control alphabet-agencies of the Imperial secretariat.

        I strongly suspect that it won’t make any substantive difference which candidate is elected President, in this election or any future one. There is a faint hope that the satrapies of Europe can be wrested out of the Empire’s sphere, but I think it’s too late for that, too.

        • Mike Meyer

          I appreciate the reply.
          I am in complete agreement
          with you,”…about the threats to civilization posed by the out-of-control alphabet-agencies of the Imperial secretariat.”
          Please define “Imperial secretariat “.
          Who gives orders to Obama ?

          • Gordon Barlow

            Wikipedia has reasonably good explanations of “secretariat” and “Deep State”. Go with those.

          • Mike Meyer

            Have you been able to determine individual suspects within the “Deep State”?
            [I prefer the term “Secret Government” as used by the Christic Institute in there
            investigations decades ago.]
            I need actionable intelligence on who exactly commands the commander.
            Thank you.

            Individual board members…….?
            Royal or U.S. Elite family members…..?
            Committee of 300 etc……?

          • Mike Meyer

            Correction;The term used was “shadow government”.

          • Mike Meyer


          • Mike’simple mind’ Meyer

            Please excuse the incomplete posting.
            Website;Alcuin and Flutterby
            provides thought provoking information
            such as;
            …..the International Bar Assoc.the American Bar Assoc. and the U.S.Department of Justice are commercial derivatives and subsidiaries of the Crown Templar
            or Temple Crown[HQ,London].

            My goal in communicating with you here Gordon is to identify white collar terrorism suspects.
            If you are unable to assist at this time that is fine.
            Thanks again for your informative comments….

          • Gordon Barlow

            C’mon, Mike! Sheesh! Man! I live on a small island. I only know what I read in the newspapers. (Will Rogers said that; I don’t think he’d mind my stealing his line.) I have opinions, so you’ll have to dig for your own suspects, I’m afraid. Also, I don’t really think you’re likely to bump into any desperados here on George W’s blogsite!

  • This dovetails with this article. Nov 23, 2015 What Happens When Cities Make Homelessness a Crime

    Hiding The Homeless A growing number of American cities are ticketing or arresting homeless people for essentially being homeless. The new laws ban behavior commonly associated with homelessness like reclining in public, sharing food or sitting on a sidewalk.