Flash calls his fund a 'micro-macro' fund because he looks for macroeconomic trends and trades them with microscopic amounts of money. This enables him to stay relaxed. Trading is a way of figuring out how things are working in the world, and as he’s not reliant on it for all of his income, he can afford to make some stupid mistakes. Which he has done plenty of.
Currencies: A Race To The Bottom?
What’s going on the forex markets? You could be forgiven for thinking that the dollar would weaken as the US government announced another few trillion of spending, but no. The dollar ended yesterday stronger against all the main currencies except the yen.
Stuck To The Dollar
As currencies devalue, people have to buy even more dollars to pay down their debts. So there’s a self-reinforcing trend. And even though the Fed is printing money, there still aren’t enough dollars to go round. When dollars were cheap and US consumers were spending, it was easy to borrow. The banks were happy, ‘cos they could get hold of cheap dollars and convert them into loans in their home currencies, then package up their loan books and sell them on as AAA-rated securities to raise yet more cash. That’s how HBOS, RBS, Northern Rock etc grew their lending and fuelled the UK property bubble.
So, a growing problem for the UK banks is that they have loads of commitments (e.g. complex deals involving asset backed securities, US packaged loans, credit default swaps) denominated in dollars which now cost more to service. If your balance sheet is in pounds sterling, dollar-denominated debts is effectively costing you more.
A weak pound = poor health for the banks. It’s often observed that when sterling strengthens, so do the UK banks, and vice versa.
It’s not in their interest, or that of any big corporate with dollar-denominated debt, for the pound (or the euro) to carry on depreciating against the dollar. So another reason for some of the wild swings we’ve seen could be big corporates having to hedge these big risks. Currency trading is dangerous at the best of times but right now it can be lethal. There are a lot of nervous elephants stomping around in the forex jungle.
What Would You Do If You Had Euromillions?
Here’s a question to ponder. What would you do if you won a million pounds (or euros) in the current climate? Go out and spend it? Where would you put it? How would you use it? Your answer may provide some clues about how to read the macro picture. Would your No. 1 priority be to pay down debt? It would be mine. The second thing I’d do is take a long holiday, then I’d look for something innovative to invest in. But not until I’d paid off all my debts – mortgage, credit cards, overdraft etc. I ‘d want to reorganise my finances to become much leaner and more efficient.
And that’s roughly the situation a lot of big corporate entities find themselves in. They’re desperate for capital and they have to reduce spending and conserve cash at all costs. Of course they’ve just lost the debt lottery, not won it, and to make it worse their share capital is also in tatters (which is one of the reasons we’re seeing so many rumours of rights issues).
Big Eurotrouble
The debt situation in Eastern Europe is getting worse by the day. A nasty side effect of currency devaluation (Iceland has been the textbook case for this) is that it creates unwanted stress in credit markets. The rouble, the Polish zloty, the Hungarian Forint and any number of other currencies are collapsing. So any debts denominated in foreign currencies become much more expensive to service, raising capital becomes more expensive, and you also get import price inflation – i.e. the cost of buying commodities in your home currency goes up. (This pressure is being offset by the decline in the cost of raw materials – it’s exactly the opposite dynamic to the commodity bull market – high demand, weakening dollar – we had in the first half of last year).
On the other hand one could argue that a softer currency makes labour costs more competitive, and it’s also good for exports. But right now trade is at a low ebb – no-one’s buying anything much, and stock levels remain at all time highs. That translates into lay-offs and factory closures; thus rising unemployment and creating a self-reinforcing cycle of economic decline. To make it worse the eurozone is getting into a heavy political deadlock about macroeconomic policy, with rows about protectionism and how to manage an economic stimulus, and growing civil unrest. There’s a single currency but no single government to make decisions. Many Eurozone banks are wildly overexposed to eastern european debt, with the risk of default coming closer and closer each day. And eurozone interest rates are still too high, in my view. For this reason I’m even more bearish about the prospects for the eurozone than I am for the UK, and just keep adding to my short euro positions.
A contrarian question: what would happen if the euro went to parity with the dollar? I don’t know the answer, and I don’t think it’s impossible.
How Am I Trading This?
On currencies, I’m running very simply with a longstanding short EURGBP position (from 9450), and a short EURUSD position from 1.3730, which I’m adding to when I see selling opportunities. I’m inclined just to leave them to run for the moment.
I can see that more gold buying could easily be on the cards, particularly if equity markets lose their appetite for gains. As I hinted in a previous blog, on balance I’m more sympathetic to the bear case for gold, because I don’t think the dollar is going to weaken quite as much as a lot of people seem to expect. Cash is king, and cash = dollars. In the meantime it’s entirely possible that there is more to be played for on the upside in gold. But I’m not going for it. Rather, I’m looking for shorting opportunites.
So the aim of the game is to try to stay relaxed, and not to overtrade. I think there’s plenty of downside risk. Earnings going forward look like they’ll be dreadful (which means that the S&P could head down to 600 or below); and that’s another reason to maintain a short gold position. In a deflationary, depressed economy, why would gold need to trade above $900 an oz? $600 or below would be more reasonable. Everyone will have to sell it at some point to raise cash anyway, won’t they? If, on the other hand, lending levels do recover, consumers begin to spend again and China doesn’t collapse then we might, perhaps, see some modest inflation and some currency debasement. In that scenario gold might be just the ticket, although to be honest I think gold is already pricing in big inflationary pressures which aren’t really there.
Dollar vs Gold
So a (relatively) strong dollar and strong gold? Odd. One or the other is likely to give. I suspect that gold that will be the loser. I don’t see much chance of a full-blown commodity bull market for another six months yet. But I could always be completely wrong…
What would upset this view? Well, if there was a serious move towards euro-buying then it would be an indicator of risk appetite returning to equities, and then a long position in gold might make much more sense. Or if there was a loss of confidence in the dollar as a ‘reserve’ currency. But are we at that point yet? I suspect deflationary unwinding and deleveraging has further to go.
| My Rating |  | Overall Rating for this post | |
February 11th, 2009 at 12:45 pm
“As currencies devalue, people have to buy even more dollars to pay down their debts”.
What do you mean by this? What people??
“So there’s a self-reinforcing trend. And even though the Fed is printing money, there still aren’t enough dollars to go round”
I dont know what you mean by this ?
“When dollars were cheap and US consumers were spending, it was easy to borrow. The banks were happy, ‘cos they could get hold of cheap dollars and convert them into loans in their home currencies, then package up their loan books and sell them on as AAA-rated securities to raise yet more cash. That’s how HBOS, RBS, Northern Rock etc grew their lending and fuelled the UK property bubble”
Are you just saying here that the UK banks borrowed in Dollars to fund their lending cheaply ??
“So, a growing problem for the UK banks is that they have loads of commitments (e.g. complex deals involving asset backed securities, US packaged loans, credit default swaps) denominated in dollars which now cost more to service”
Why din’t the banks just hedge there positions ????
“A nasty side effect of currency devaluation (Iceland has been the textbook case for this) is that it creates unwanted stress in credit markets. The rouble, the Polish zloty, the Hungarian Forint and any number of other currencies are collapsing~”
I dont understand what you are saying here.. Why did the other currencies collaspe ?? Contagion ??
“i.e. the cost of buying commodities in your home currency goes up. (This pressure is being offset by the decline in the cost of raw materials – it’s exactly the opposite dynamic to the commodity bull market – high demand, weakening dollar – we had in the first half of last year).”
Many countrires have dollar reserves so would they be effected in this case…. ??
“A contrarian question: what would happen if the euro went to parity with the dollar? I don’t know the answer, and I don’t think it’s impossible.”
The dollar is a garbage curency and its strength is only due to global delegeraging and unwinding of risk. Once risk appetite improves, dollat will weaken and Yen will strengthen… you cant just print dollars all day and expect the curreny to hold value….
“So a (relatively) strong dollar and strong gold? Odd. One or the other is likely to give. I suspect that gold that will be the loser.”
Hmmmm I’s quesntion that. Gold has stood the test of time thousands of years.. Whats the longest a fiat currency has ever lasted or can ever last due to the design the system…
All currencies will be destroyed overtime….
thougts and cooments welcome…
February 11th, 2009 at 1:14 pm
I think you answer your question about what anyone with any money would do with it. They’re not giving it to shaky banks who pay no interest and where its value will decline. They’re not buying industrial commodities that nobody needs. They’re not buying shares while prices are collapsing and earnings are vanishing.
So what’s left? Gold. It is proven over centuries as a store of value and its big drawback — no income — is a goner in a world of low/zero interest rates.
In my opinion, a return of risk appetite would have the opposite effect to the one you suggest. People would then realise the capital they have locked up in gold in order to reallocate to the asset classes they are currently avoiding.
February 11th, 2009 at 1:15 pm
…well, if you check the links in the blog to my various research sources you’ll see how I’m building my argument…I’m not saying I’m right, it’s just the view I’m taking at the moment. I suspect we will have to disagree!
eastern european currencies are collapsing cos of weak demand, lower commodity prices and a lot of foreign debt. Many people in eastern europe have mortgages denominated in euros, and a lot are totally unhedged So imagine how you would cope if the amount you owed on your mortgage went up by 28% in six months! And at the same time wages are lower and jobs are scarce. Most emerging markets are very very exposed to euro and dollar debt. And this is really dangerous when your currency goes down in value – it creates a self-reinforcing spiral of decline. Toxic for european banks, many of which have been busy buying up eastern european banks – often in heavily geared transactions. The system is broken.
February 11th, 2009 at 1:20 pm
agree up to a point about gold, as you can see from my previous blog, but I just think its overpriced in relation to the rest of the commodity complex – look at this chart of the gold/oil ratio! I understand the dynamic – just don’t think it’s sustainable.
http://ftalphaville.ft.com/blog/2009/02/05/52092/the-gold-to-oil-
ratio/
And owning the dollar is still more useful than gold in a deleveraging environment, I think.
February 11th, 2009 at 2:20 pm
I am not saying your incorrect, just pondering some thoughts..
How come the debt for the eastern european countires is in euro’ as well as how come there mortages are in euro also ?? Whynot in there own local currency…?
which commodities do eastern european countries produce ?
It is not correct to say gold has no yield. Gold can be leased out by CBs for hedging..
February 11th, 2009 at 2:27 pm
& what do you mean bu this point… please explain.
As currencies devalue, people have to buy even more dollars to pay down their debts. So there’s a self-reinforcing trend. And even though the Fed is printing money, there still aren’t enough dollars to go round.
February 11th, 2009 at 2:53 pm
When the euro was cheap (like dollars used to be) and emerging market currencies were higher, it seemed to make sense to take out euro (or CHF) denominated mortgages – interest rates were lower, the currency seemed more stable (less prone to inflationary pressure) and it looked like EM currencies were going to appreciate/stabilise against the euro in a move towards eurozone convergence – ie. eastern european countries wanting to join the euro. Now its a triple whammy – property prices have collapsed so you’re looking at negative equity; currencies have collapsed against the euro so debts are more expensive to service; and real incomes have taken a hammering as trade declines and unemployment rises. Millions of businesses and individuals unable to service a massive debt burden. Huge deleveraging and a big headache for the eurozone banks. That trade has all gone very very badly wrong. For a prescient account of it (written almost a year ago now) take a look at this blog:
http://macrotraderdiary.blogspot.com/2008/04/stress-bunnies.html
February 11th, 2009 at 3:00 pm
It costs more in local currency to buy dollars. So dollars are more expensive. Eg. they used to be cheap – you could get $2 for £1. That’s what protected the rest of the world, outside the US, against the spike in commodities, up to a point. Now it’s all different. Check out the rouble/USD exchange rate to see how much Russia is suffering.
http://www.exchange-rates.org/history/RUB/USD/G/M
Plus commodity prices (key source of Russian wealth) have collapsed. Russia was booming a year ago with oil and gas at record highs – roubles bought more dollars, and commodities were sky high: now it looks perilously close to bust, as they can’t even shift their oil/gas when oil is at $38 a barrel.
February 11th, 2009 at 3:02 pm
Another useful reference – and now I need to get on with something else!
http://www.creditwritedowns.com/2008/10/shift-to-eastern-europe-and-emerging.html
February 11th, 2009 at 3:06 pm
Well, anyone who ignored what I’ve had to say about gold must have a big smile on their face by now!!
February 11th, 2009 at 3:18 pm
Thanks very informative
so finally what actually caused the collapse of the easternt european currencies. Why did they depreciate so fast…
Was it investors pulled out investment from their stock markets and sold off the currency of was there currency devalued by the goverments themselves..
Why does falling oil prices cause pressure on the rubble?
thanks
February 16th, 2009 at 12:38 pm
Here’s a very bearish article which makes the dangers of the currency situation in eastern europe crystal clear! (or, why you should still be selling the euro, in my opinion….)
http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/4623525/Failure-to-save-East-Europe-will-lead-to-worldwide-meltdown.html
February 16th, 2009 at 12:54 pm
I read this earlier. Very good indeed…
I have read more about the east european crisis brewing over the weekend…
Looks to be a ticking time bomb…
February 16th, 2009 at 11:36 pm
Even more on eastern european debt here:
http://ftalphaville.ft.com/blog/2009/02/16/52508/forex-failure-continues-in-poland/
“To make his point Evans-Pritchard quotes Morgan Stanley’s Stephen Jen on the fact that Eastern Europe has borrowed a total of $1,700bn abroad. Furthermore about $400bn of that debt has to be rolled over this year – a number equivalent to about a third of the region’s GDP.
As we outlined a couple of weeks ago, the concern is now greatest not for the retail mortgage sector, which practiced the issuance of foreign-currency based mortgages on a grand scale, but for corporates — which it appears practiced the art of derivative forex exposure on an even grander scale.”
February 19th, 2009 at 11:36 pm
The Economist nicked my headline!
http://www.economist.com/finance/displaystory.cfm?story_id=13129949
I agree with them.