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How Currency Devaluation Can Be A Bad Thing

Tyler Durden's picture




 

Even as the dollar keeps hitting new daily lows, which continues being seen as a positive for the stock market, if not so positive for what little remains of world trade, not much has been said about the efforts by Latvia to do all it can to devalue its currency in the wake of a failed bond auction. The consequences are already metastasizing, as seen by the increasing volatility of related currencies, particularly the Swedish Krona which has been hit hard against the Euro on concerns of the country's exposure in Baltic states. Proposals by the Latvian government to rectify the lack of trust and to adopt a mortgage holder liability cap have not been met with enthusiasm. According to Commerzbank analysts any improvements attained from this, and other comparable devaluation approaches, would not achieve long-term goals and at best would result in short-term benefits. From Bloomberg:

A devaluation would still hit corporate loans and bring
with it “a wave of insolvencies,” said Lutz Karpowitz and
Antje Praefcke, Frankfurt-based currency strategists at Commerzbank. “Inflation would probably be
even more difficult to get under control. The relief would be
short-lived.”

 

The proposal by Prime Minister Valdis Dombrovskis on Oct. 6
to cap mortgage holders’ liability ignited speculation that the
country’s authorities might be contemplating a currency
devaluation by limiting the domestic losses that such a move
would incur. Sweden’s krona dropped against the euro on concern
the mortgage proposal may trigger bigger losses at the country’s
banks, which dominate lending in the Baltic region.

With the EU, IMF and Sweden already very much pregnant in Latvia, compliments of a $11 billion bail out package, the fate of Latvia may be much more inversely aligned with that of the surging Euro than most expect. Ironically, a strong Euro is just what a weak Europe does not need, as already 20 of the bloc's 27 countries are projected to experiences budget deficits significantly above the Eurozone's statutory limit of 3% as seen in the graphic below:

And with the obvious implication that a regional devaluation would have adverse impacts for lender countries, the question becomes how long can a US-funded IMF (which in turns get its capital from foreign countries purchasing its bonds) avoid the dreaded contagion effect.

The Swedish banks that made euro-denominated mortgages would see
foreclosures surge as fewer borrowers would be able to make payments.
Latvia also would likely lose any chance of being allowed into the euro
zone soon.

Yet one wonders just what is the tradeoff from a European perspective to keeping the Euro at such painfully high levels: with exports to the US becoming prohibitively expensive, and the possibility of a peripheral currency crisis looming, is the only benefit merely externalities to European capital markets courtesy of a surging US equity market? And the bigger question is how long before, finally, Europe realizes that relying on a US printing press, which in turn needs 100% backing from a stimulus heavy China, could prove dangerous to its health?

 

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Thu, 10/08/2009 - 09:55 | 92722 Divided States ...
Divided States of America's picture

Is this a race for the countries of the worse financial situation to devalue their currencies?? I think that if all these countries start doing that and if everything is priced off USD...we are going to get global inflation, on the scale of Zimbabwe.

Thu, 10/08/2009 - 10:02 | 92729 Gilgamesh
Gilgamesh's picture

ZH and many loyal readers have long been on to the pending currency wars (mostly USD, GBP, CHF, EUR - by design is likely to be late to the battle, and some Asian currencies already are constantly fighting with as little force as they have by purchasing dollars against their own).

 

But this would not have the effect you state.

Thu, 10/08/2009 - 10:14 | 92752 Keyser Soze
Keyser Soze's picture

So...we're long printing press companies?

Thu, 10/08/2009 - 11:53 | 92857 Anonymous
Anonymous's picture

Yes, but after the devaluation, immediately move in shopping cart manufacturers to transport your newly minted dollars. Bicycle lock distributors would be a complementary play.

Thu, 10/08/2009 - 13:25 | 93033 callistenes
callistenes's picture

No dude we're long commodities, in this case ink.

Thu, 10/08/2009 - 11:49 | 92848 JR
JR's picture

If this is a race to devalue currencies, Austrian economist Ludwig von Mises concurs with your conclusion. “At the end of the competition is the complete destruction of all nations’ currency.”

A nation’s currency system should be sound, stable. Yet proponents of monetary devaluation have set a “flexible” standard,” without the discipline of gold, as the most appropriate monetary system: it is they who pick the winners and losers.

The alleged blessings of monetary devaluation are temporary only.  Says Mises: “Moreover, they depend on the condition that only one country devalues while the other countries abstain from devaluing their own currencies.  If the other countries devalue in the same proportion, no changes in foreign trade appear.  If they devalue to a greater extent, all these transitory blessings, whatever they may be, favor them exclusively.  A general acceptance of the principles of the flexible standard must therefore result in a race between the nations to outbid one another.  At the end of this competition is the complete destruction of all nations’ monetary systems.

“The much talked about advantages which devaluation secures in foreign trade and tourism,” adds Mises, “are entirely due to the fact that the adjustment of domestic prices and wage rates to the state of affairs created by devaluation requires some time.  As long as this adjustment process is not yet completed, exporting is encouraged and importing is discouraged.  However, this merely means that in this interval the citizens of the devaluing country are getting less for what they are selling abroad and paying more for what they are buying abroad; concomitantly they must restrict consumption…

“The actual effect is that the indebted owners of real estate and farmland and the shareholders of indebted corporations reap gains at the expense of the majority of people whose savings are invested in bonds, debentures, savings-bank deposits, and insurance policies.”  Human Action Third Revised 1966, pp 790-792

At the same time, of course, all those manipulated credit expansion funds in the hands of the chosen are promptly ending up in the stock exchange, hence the rise in stock prices.

Thu, 10/08/2009 - 12:44 | 92963 ghostfaceinvestah
ghostfaceinvestah's picture

Excellent post, JR, good quote.

Thu, 10/08/2009 - 09:59 | 92725 Anonymous
Anonymous's picture

Jim O'Neill from Goldman Sachs discounted worrying and concern about Latvia on CNBC this morning. GS doesn't lie. He said, "People are finding new things to worry about every day." Thus, there's nothing to worry about. Sounds like a buy signal to me.

V!ctory for the BULLS!

Thu, 10/08/2009 - 10:18 | 92753 Gilgamesh
Gilgamesh's picture

If Jim is now coming on CNBC to pump stocks and discount worries, this tells me that GS is looking to lure in the last of the suckers (i.e. CNBC-watching retail investors still stuck in money markets).  Very revealing.

Thu, 10/08/2009 - 10:35 | 92768 Anonymous
Anonymous's picture

This is precisely the reason for the length of this rally. So far, the retail long has not bit. They have to keep ramping up. The trouble is, whoever is holding all of this crap has huge BS risk. We'll know when GS, uh, I mean the guilty party goes from reporting record revenues back to Congress begging for another bailout at the risk of catastrophic collapse of the world monetary system. The only meaningful question I see on the horizon is just exactly when government buildings start to burn.

Thu, 10/08/2009 - 12:13 | 92904 Anonymous
Anonymous's picture

ABSOLUTELY! SPOT on! How do we play it, though? I'm thinking LEAPS on "Vampire Squid" repellent.

Thu, 10/08/2009 - 10:01 | 92727 AN0NYM0US
AN0NYM0US's picture

From CNN yesterday

ALLEN SINAI, DECISION ECONOMICS: Well, a declining dollar is a sign of a declining country in terms of economic power and wealth and its prospects. For ordinary Americans, it means things would cost more if the dollar keeps going down. Things we buy overseas, things we buy at home, the purchasing power goes down.

 

http://transcripts.cnn.com/TRANSCRIPTS/0910/07/ldt.01.html

Thu, 10/08/2009 - 10:05 | 92734 Divided States ...
Divided States of America's picture

Guess what currency the elites and the riches of America own? Definitely not the greenback. Thats saddled for the middle class and low class Americans

Thu, 10/08/2009 - 11:03 | 92806 reading
reading's picture

That's not what Steve LIESman said.  He said a dollar going down isn't bad as long as the assets you buy with it go up in value...that's the story and they're sticking with it.

Thu, 10/08/2009 - 10:02 | 92728 Anonymous
Anonymous's picture

I identified this as a possible problem weeks ago when S&P downgraded Latvia to junk (yes, unfortunately, these moronic rating agencies still carry substantial weight!). Latvian economy expected to contract 18% in 2009. The new government, cobbled together with 5 parties, is an unweildy coalition at best. 2 of the parties are already complaining about the severe austerity measures. Failed bond auction yesterday (w/o aa single bid!) is a logical step in this process.

But, one country's devaluation is likely to be "handled well" by ECB/IMF. The real effect will be if Lithuania and Estonia see the "success" of Latvia's devlauation and decide that that is the easier way out for them too.

The real domino effect will be only if Poland/Ukraine/Romania get into trouble. That (I am not saying they will) can bring down the European banking system and trigger a weak Euro (and ergo a stronger $), which will be the driver of collapse in risk asset prices worldwide.

Remains to be seen how this plays out, "social unrest" in these countries is what I am watching (I don't wish it upon anyone, but it is likely if your government all of a suddent imposes 20% haircut on salaries etc. as demanded by the IMF). Eastern Europpe/Baltics is the focal point of any potential trouble.

Yet, now that the news is out ion the WSJ, me thinks this won't happen. A watched pot seldom boils!

Thu, 10/08/2009 - 10:21 | 92756 Anonymous
Anonymous's picture

A watched pot always boils, not as quickly as you may want want or think...but, in the end, it always boils!!

Thu, 10/08/2009 - 14:21 | 93153 Art Vandelay
Art Vandelay's picture

The actual expression is, "a watched pot never boils".

Fri, 10/09/2009 - 00:35 | 93831 floydian slip
floydian slip's picture

confucious say: smoked pot allows the watching of the pot to boil more easily

 

Thu, 10/08/2009 - 10:34 | 92765 Oso
Oso's picture

I think it is inevitable for a crisis to emerge.  The fact of the matter is, CDS spreads have become incredible narrow on a lot of these countries, which means people have stopped believing it as a risk.  US Media, with the exception of two small articles in Journal and Bloomberg, have really no idea that this is a problem.  Its like before Asian Flu.  You dont have just one currency devalue.  It never happens like that when every one of those countries is in the same exact boat. 

 

Everyone should check out Kyle Bass' latest piece from Hayman - they have a nice chronology and commentary on '...the sheer ridiculousness of Latvia's IMF-led bailout.'

 

Poland is supposed to be the strongest, and even they had a failed bond auction a few weeks ago.

 

The fact that people are trying to tell you it isnt a risk should be a giant f'ng red flag.

Thu, 10/08/2009 - 10:07 | 92733 Miles Kendig
Miles Kendig's picture

We have come upon the can that got kicked down the road from this past winter & early spring.  Now the stalwarts of Western Continental Europe may well join the CEE if the dynamic of the race to the fx bottom coupled with economic relativism and rough equivalence is not matched by the EU and the emerging Europe funding currencies this round.  The Swiss have made some noises recently.  It will be interesting to see what happens next since it is becoming increasingly more challenging to simply paper over this metastasizing situation.  Indeed, trade is once again finding its place on stage.

Thu, 10/08/2009 - 10:08 | 92739 Printfaster
Printfaster's picture

I have long said that the claim that US was the largest economy was bogus and founded on a dollar whose value could not be sustained.  These massive debts are not a sign of strength, but a sign of weakness.

What happens to the US place in the world economy if the dollar declines by 1/2?  By 3/4?

What happens is that China and Europe replace the US as largest markets and the US becomes a second rate country with less influence than Russia.

Thu, 10/08/2009 - 10:45 | 92783 Anonymous
Anonymous's picture

Doesn't everyone else devalue also? It seems the markets don't want us to get too far ahead in the inflation game. The net would be the same, world inflation to pay debt or deflation and debts written off. If you are the banking elite it will be easier to stay in control through inflation worldwide. Once they even out the playing field, SDR's become more realistic. I voted for Obama and it looks like he is in line to become the biggest patsy of all time.

Thu, 10/08/2009 - 10:53 | 92791 ozziindaus
ozziindaus's picture

Haven't we already agreed that China is actually cheering a USD devaluation? IMO, it would take a major back stabbing by China to disregard the US as the major economic player. A stabbing answered only by a gun.

Thu, 10/08/2009 - 10:09 | 92742 curbyourrisk
curbyourrisk's picture

Sweden's exposure?  Doesn't the US have swap lines open with all of the Baltic States??????

Thu, 10/08/2009 - 10:27 | 92760 Anonymous
Anonymous's picture

All the big banks are Swedish owned in Estonia... The largest is SEB, former Uhispank, next Swedbank, former Hansapank.

Thu, 10/08/2009 - 10:11 | 92747 Anonymous
Anonymous's picture

The problem, in my mind, is productive versus non-productive business. The biggest issue with creating these liquitiy "plumes" is that they encourage businesses that have no productive component to them while at the same time destroying the remaining productive ones. Meaning, nothing productive can come from GS gaming the crude markets, but in the current enviroment it is no doubt the most profitable business to be in...

In the end, the system will collapse as the remaining productive business continue to contract... Our current path is no doubt unsustainable..

Thu, 10/08/2009 - 10:11 | 92750 mrgneiss
mrgneiss's picture

Sorry my comment isn't directly related to the above article, but I just came across a great video with the "Rich Dad, Poor Dad" author Robert Kiyosaki really slagging GS and the Fed and promoting silver.

http://www.youtube.com/watch?v=gfgrAKS-sto

Thu, 10/08/2009 - 10:31 | 92763 aus_punter
aus_punter's picture

i think Trichet appearing on tv quite a lot of late and trying to talk up the $ is a sign that Europe definitely appreciates the ramifications of Bens presses running day and night.

 

Thu, 10/08/2009 - 11:53 | 92856 orca
orca's picture

Tyler, we are fucking hurting over here in Europe, but anecdotally from fellow traders and several clients (who own and operate their own business) the consensus is that although the EUR/USD is awful, if it doesn't kill us it will make us stronger. Imports are much cheaper, bot raw goods and (half-) finished products. Much of the trade has moved from EU-USA to inter-EU. Moreover it is a question of dignity, we control our fate. I know we have shitloads of shit in the Euro area, but we cope (just).

Thu, 10/08/2009 - 12:11 | 92899 JR
JR's picture

Remember the human side of currency devaluation expressed by Latvian blogger now living in the United States, Mara, posted in June on Naked Capitalism?

Now the average Latvian is getting wages cut (if they aren't being fired outright) and many social and government institutions are cutting back dramatically or closing entirely. Why? Because Swedish banks needed to be bailed out of criminal loans with IMF money and the Latvians will suffer for this for at least a decade.”

Said Mara, “The unfathomable part was the government's nodding acceptance to borrow from the IMF to pay for bad private loans given out by mostly Swedish banks (for vastly overpriced real estate).  Some of the loans were to locals, some other nationalities that wanted 2nd homes in Latvia. My understanding is that most of the mortgages were full recourse, but certainly not guaranteed by the government…”

Concluded Mara, “I would...outlaw mortgages being denominated in foreign currencies and/or payments tied to forex fluctuations, since agreeing to such terms is similar to prostitution, except it costs you, lasts for 15-30 years and does not come with lubricant.”

It’s just too bad for Latvians that, according to Nouriel Roubini writing June 11, that  the “large foreign liabilities of households, companies and banks are in foreign currency,” and that “the real value in local currency of such debts would increase sharply after a devaluation.”   And that to delay the “domestic and international costs” would make the “unavoidable crash—and the regional contagion—even more dramatic and cosly.”

The IMF/World Bank is the protégé of the Federal Reserve – with a sordid history of its members getting rich alleged fighting poverty.  As Graham Hancock, an astute observer of the international-aid industry, said in his book, “Lords of Poverty”: [M]oney has never been easier to obtain… [W]ith no messy accounts to keep, the venal, the cruel and the ugly are laughing literally all the way to the bank… All they have to do…is screw the poor.”

Thu, 10/08/2009 - 12:49 | 92969 Hephasteus
Hephasteus's picture

The world bank can suck rocks and die. The IMF can die screaming.

Thu, 10/08/2009 - 13:05 | 93001 orca
orca's picture

Borderline meltdown on EUR/USD as we speak, 1,4816, +142 pips, just unreal. Overnight futs both here and the Japs are starting to slide away too.

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