Is a Currency Crisis Next?

Paul Krugman says there are "clear signs of currency crises throughout the world of emerging markets":

The mother of all currency crises, by Paul Krugman: ...I’ve been reading reports from Stephen Jen, a former student of mine who’s now the chief currency strategist at Morgan Stanley. He points out that since the fall of Lehman, we’ve been seeing clear signs of currency crises throughout the world of emerging markets, including Eastern Europe. This time, it’s not an Asian crisis or a Latin American crisis, it’s a global crisis. ...

Dani Rodrik calls for the IMF to take immediate action to avoid "the mother of all currency crises," and the potential for a "vicious cycle of unemployment and protectionism":

Urgent need for IMF action, by Dani Rodrik: Paul Krugman frets that we are about to witness the mother of all currency crises in emerging markets, and I am afraid that he is right. As I wrote in my previous post, the financial crisis in the developing world has just started and there are indications that it will get a lot, a lot worse.  What is different with this phase of the crisis is that it cannot be addressed by governments in the affected countries issuing their own fiscal guarantees and domestic currency. These countries need external lines of credit, and they need it fast before the scale of the problem becomes truly unmanageable.   

The solution is clear. The IMF, possibly along with central banks of the G7, has to act as a global lender of last resort to emerging markets. These countries have to have ample access to liquidity in reserve currencies--quickly and with few strings attached--for them to be able to fend off what may otherwise become a historic rout of their currencies.  And China should join in: it should make a portion of its near-$2 trillion of reserves available in support of this global enlargement of credit lines.

Emerging markets have every right to say that they are being swept under by a crisis that is not their own doing. But the real reason the rest of the world needs to move on this front is naked self-interest. Combine a deep recession in the advanced countries with an uncontrolled depreciation of emerging-market currencies, and the pressure to erect trade barriers in the U.S. and Europe will be impossible to withstand.  A vicious cycle of unemployment and protectionism feeding on each other a la 1930s could transform the deep recession everyone is already expecting into a second great depression. It can get worse...

I have a feeling that this will be the make-it-or-break-it week for emerging markets. I hope the IMF will make an announcement in time to make a difference.

Update: See also Currency crisis is gathering storm from Edward Harrison at Credit Writedowns. Also, "Waiting for G7 Currency Intervention: It Won’t Be Long by Simon Johnson.

Comments

[ddt]

British pound was down more in the last week than it was when Soros "broke the bank of England". Ukraine just got an IMF loan, Hungary jacked their rates from 8.5 to 12.5 but still couldnt stop the slide. i bought a small amount of EUR/HUF last Sunday and doubled my money in two days at 50x leverage. So yeah, I'd say we are already in a currency crisis verging on forex armageddon. Hungary and Turkey look like the next Icelands

[Fred]

It takes a long time to erect trade barriers, much longer than this crisis will last. What will happen in the short-run is that emerging markets are going to be facing a wave of defaults. Anyone (households, corporation, government) whose source of income is an emerging markets currency but who owes debts in the dollar/yen/euro is going to be in deep doo-dah. So what? Better to just get the pain over with now and wipe out some of this debt rather than going into hock to the IMF. The default by emerging markets will hit banks in the developed markets, and so they will go bankrupt too. Again, so what? I've long been recommending just letting a firestorm of bankruptcies clean the system out, and then a massive government deficit ($2 trillion plus) for a couple of years to prevent deflation. But idiots who can't understand Keynesian economics won't accept this. Anyone, such as the Austrians gold bugs, who opposes bailing out main street is in effect recommending bailout out wall street. The only other possibility is a long deflationary depression, but the world will not accept that (I don't think).

[hari]

Yes! Global currency crisis is next...closely linked with talks on Bretton Woods II. The role of dollar in international trade and finance was a central issue arising out of EU/Asia Summit 24-25 Oct, at Beijing.

However one must recognize Japan is not willing to forego its sole G-7 role in (IMF) international finance representing Asia. It's politically loath to admit China and India at the table, as Sarkosy and Bush may prefer right now. Also Yen is appreciating as a *defensive* currency all across the financial market this week and will likely continue....Japanese curreny reserves being a significant global factor.

What's the role of US Dollar in this financial crisis? How can one explain dollar appreciation when hi street is in meltdown? Is it simply a defensive move and/or safety first -financial houses in emerging markets are empting coffers of all foreign currency assests for Yen and Dollar.

Euro is under considerable pressure without a federal super structure (legal basis) for its existence.

[FairEconomist]

What can the IMF do? Great Britain couldn't beat Soros. Now we have tens of trillions - or is it hundreds of trillions? - in wildly unwinding currency deals and hedges. Even with China's reserves it would be like trying to save the Titanic with a bucket brigade.

[anne]

"It takes a long time to erect trade barriers, much longer than this crisis will last."

Actually the issue is not trade barriers, which hopefully will not be erected, but limits on domestic-international currency movements which as Malaysia showed in 1998 can be set up immediately, and which China and India to varying degrees already have. Malaysia limited international investment flows to and from the stock market, allowing for an orderly withdrawal by international investors.

Though the move was throughly criticized, I have too little sense as to how successful Malaysia was from a domestic perspective. Malaysia however was not forced to rely on the International Monetary Fund for assistance during the Asian currency crisis, and as such never used austerity measures the Fund would have demanded.

[esb]

Yes, let the assets pass from those who embraced debt to those who put pennies into jars.

But the real impending crisis is the "full faith and credit crisis" awaiting United States sovereign debt as the Treasury attmepts to stuff every central bank in sight with as much of the stuff as it is willing or able to hold.

The RoC (Taiwan) exited the game over the weekend and good on it.

I had thought that the PRoC would be first out the door but it seems that it needed to be shown the way.

[anne]

Hong Kong also used investment-speculation counters of a sort to weather the Asian crisis, the government deciding to buy the Hong Kong stock index to ease price declines and as has been done on a number of occasions limiting land sales to stabilize prices. Hong Kong was never going to rely on the IMF, having China proper to rely on, but as far as I can tell the government was successful in protecting the currency.

There are varying accounts of how Hong Kong weathered the recession that came with holding the Dollar peg while currencies in Asia were losing value, but I have thought recovery was fairly rapid relative to several Asian countries.

[anne]

I wonder whether Iceland should have directly defended the currency or tried investment flow controls, but I imagine the IMF would not have assisted had Iceland tried to limit investment flows. But, did Malaysia fare better than Thailand or Korea? I am sure Hong Kong fared better.

[anne]

"Even with China's reserves it would be like trying to save the Titanic with a bucket brigade."

China will not allow free capital flows in and out of the country, nor will India. That is of critical importance. China was scarcely touched by the Asian currency crisis in 1998. India, a little.

[a]

"I’ve been reading reports from Stephen Jen, a former student of mine who’s now the chief currency strategist at Morgan Stanley. "

Now that I didn't know. Is there any word other than incestuous to describe the relationship between Wall Street and economists in academia? You hire my boy, I'll promote his work, more than even money that he's talking Morgan Stanley's book?

[Fred]

>Actually the issue is not trade barriers, which hopefully will not be erected

Well, I for one hope trade barriers WILL be erected to some extent between regions which do not allow for free movement of labor. Allowing unrestricted movement of goods, capital and labor within North America is possible and a good idea. But free movement of goods and capital between North America and emerging markets is not so good, precisely because there is not and cannot be (especially in the near future) free movement of labor between these regions.

Intelligently designed barriers to movements of goods and capital are good for the average person, for as long as there exist barriers to free movements of labor. Who benefits from the current system is primarily Wall Street (and it's analogs in the rest of the world). You can bet those IMF bailouts to Ukraine, Hungary and so forth will flow primarily to the elite. Those who benefitted from the boom will also be bailed out during the bust, to the net long-run detriment of the rank-and-file.

[Winslow R.]

"The solution is clear. The IMF, possibly along with central banks of the G7, has to act as a global lender of last resort to emerging markets. "

I see no reason why the IMF should be involved.

[Don the libertarian Democrat]

Sebastian Mallaby, a man who's not given to panic, says the following in the Washington Post:

"Now all of these currency bets are exploding. The currencies that used to be cheap to borrow are soaring in value, and the ones that reaped rewards for owners are plummeting. In the past month, the Japanese yen has jumped 34 percent against the Australian dollar and 18 percent against the ruble. A lot of speculators in a lot of places are getting pummeled. The more they rush to get out of their positions, the more they reinforce the currency moves that cripple anybody who's still trapped in the carry trade. And the more havoc all of this wreaks in emerging economies.

How this plays out is anybody's guess. The same bug-eyed panic that was evident among bankers last month has seized traders of emerging-market currencies. The really scary thing is that the crisis has migrated into parts of the financial system that are tough to rescue. When push came to shove, the Federal Reserve, the Treasury and their European counterparts could stand behind the banking system. But now we are talking about hedge funds, which lie beyond the traditional reach of regulators, and emerging markets, some of whose governments lack the cash to stage bailouts. Unlike your standard horror movie, there's no telling when this one will end."

http://www.washingtonpost.com/wp-dyn/content/article/2008/10/24/AR2008102403431.html

[Dickeylee]

Until the last week or so, the flavor of the week topic
has been the unknown risks of the credit default swap
market, with a notional value of $55 trillion, down
from $62 trillion at mid year. But we learned a long time ago that, in the universe of the swaps market, the
vast majority of contracts (about 90 %) were not CDS, but interest rate and CURRENCY swaps. These were
hedges on, and bets on fluctuations between sovereign nations relative interest rates and currency
values. The notional value is about $500 trillion. So,
my question to you all is, if CDS was a big problem, and the size of this market is 10x larger, and if
huge currency swings are currently in progress,
are failures in this swaps arena a bigger danger than CDS?

[egc]

Here's the link to Ambrose Evans-Pritchard's piece from the Telegraph (UK) and cited by Edward Harrison:

http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/3260052/Europe-on-the-brink-of-currency-crisis-meltdown.html

[Too Much Fed]

See this article about past bubbles and past real interest rates after the bubbles (1929 , 1873 , 1825 , 1773 , 1721):

http://www.prudentbear.com/index.php/commentary/guestcommentary?art_id=10141

Will the real currency crisis eventually be the dollar????

See this article titled "Confusion reigns: A crisis-driven global rush to dollar liquidity is not deflation"

http://www.itulip.com/forums/showthread.php?p=52818

"In the crisis stage of a debt deflation, defined by Fisher and Minsky as a reduction in debt financing, credit and money market panic causes banks to stop lending and borrowing from each other, pay off existing loans to shore up their balance sheets, and build reserves against expected future losses. This creates a short term spike in demand for the currency in which the debt is denominated, in the current case dollars. To the uninitiated, this looks like monetary deflation. A strengthening currency and falling interest rates also characterizes monetary deflation. That can in time produce commodity price deflation, so the confusion is understandable. But don't be fooled."

Read the rest!

[lark]

Okay, somebody explain how American growth can resume without a resurgence in manufacturing.

The credit bubble is OVAH. Real estate and finance are OVAH.

Let's stop thinking about this from the Wall Street point of view. Where are the nextgen jobs going to come from?

And if we do get jobs from manufacturing, don't we need protectionism? Because China will never abandon the peg, least of all now, in a meltdown.

[Dirk van Dijk]

"It takes a long time to erect trade barriers, much longer than this crisis will last."

Who needs trade barriers if there are no letters of credit and the baltic dry has collapsed. The lack of letters of credit is the financial equivelent of a fleet of U-boats prowling every major shipping lane. Note that container traffice inbound at the port of LA/LB is down about 12% yr/yr. Doubt it is the end of the decline by a long shot. Trade will contract w/o any need for gov't help.