Coordinated currency intervention may not be far off. I am not making a prognostication that this will happen. That is far to complex an issue to make a ‘call’ on. I want to make a case that the conditions are either presently with us or soon will be upon us for currency intervention to become an option that is exercised.
In my opinion there were at least a half dozen times in the past 18 months where currency intervention could have been an option to provide stability to a global financial system that was cracking up. But there was no coordinated intervention in the FX market. There were an unprecedented amount of fiscal and monetary actions taken by nearly every country in the globe, but it never came down to FX intervention as a policy option.
I bring up this history to re-enforce my point that intervention is impossible to call and is, based on recent history, a remote possibility. That said, should it come in the next few days and weeks it would be a measure of just how much pressure is building up and how unstable the system is.
Central bankers know they can’t control the value of their currencies. The markets are far bigger than the central banks. The best they can do is slow a process. A checklist for decision-making on coordinated intervention would include some of the following:
- How quickly is the market moving? Is the rate of change orderly?
The movement in the $/Euro has not been disorderly. We have a 10% recent peak to trough move. That is big in currency land but it would not by itself be a justification to intervene and provide temporary stability.
A different way to measure how much stress there is out there is to look at the Euro/CHF rate. The Swissy has strengthened by 3+% of late. That may look like peanuts compared to the moves in the dollar. But it is actually a big deal. The SNB has been intervening to hold the 1.51 parity to the Euro. They gave that up after a long fight. Now they just look silly for having drawn a line in the sand then backing off. The Swiss just hate what is going on.
If you want to look at stress look at the move in the $/Yen and the Yen/Crosses yesterday. The two big figure moves might be considered disorderly. I am sure that there are some Yen traders that are puking in the garbage pail. The Japanese CB hates this. They don’t want a strong Yen and they hate when it gets moving too fast
- What is the cause of the capital movements?
It’s the sovereign story that is driving this. This is a bizarre factor that is driving the Euro/$ rate. The GDP of France and Germany are many multiples of that of Greece. Think of this as if the state of Utah was having a budget crisis. You wouldn’t dump the dollar just because of that. Yes, we have Portugal and Spain to consider (Italy, in my opinion should be taken out of the PIIGS). So go back to the US comparison and you have Utah, Georgia and Connecticut to worry about. But step back a bit, we are trashing the Euro based on this. The real comparison to the US and the EU is not Georgia or Utah; it is California and New York. The deficits and problems in these two states balance the problems in Athens and Madrid on the currency scale.
There is nothing rational about our markets. But moving massive amounts of money around the globe because of problems in Greece is not rational. I say, “Never fight the tape”. Central bankers can’t say that. There is a good excuse for them to fight this tape.
- Is the rapid change in FX rates creating collateral damage?
Boy is it. Just look at the tape. This Greece story has gone global. It is raining deflation on us. VIX on everything just shot up. A few more weeks of this and you start taking points off of global GDP.
- What is the implication to the US?
The big Boss made a speech a week ago and said that we had to export our way out of trouble and export to create jobs. Well you can kiss that plan goodbye if the dollar keeps rising. You think this is good for John Deere (DE), Caterpillar (CAT), IBM, Microsoft (MSFT), Apple (AAPL), Boeing (BA), Cisco (CSCO) or Intel (INTC)? This is not good at all. It is one of the reasons the DOW is getting smacked so hard. A strong dollar is a decidedly brown shoot. Go ask Disney (DIS) or Mike Bloomberg. How much do they make on foreign tourism? The White House knows this. I doubt Geithner does, but there are plenty of others (Volker/Summers) who understand the implications of this. Bernanke knows this. He has bet his career on something. It could get derailed if the dollar gets too strong too fast. Everyone in D.C. hates what is going on. They are looking for solutions. Intervention is the one thing that is on the shelf.
- If left unchecked where could the instability lead?
This is a slippery slope we are on. The markets seem to have Greece in their cross hairs. But this will pass and those with loaded rifles will point them elsewhere. This sovereign story could spread very quickly. It could jump out of Europe and go to Mexico overnight. It could go to Asia and make a mess of Indonesia, the Philippines and Korea. Once it gets started it will be very difficult to stop. It is already moving fast. It could go global in a week. The worst possible outcome is that it goes uphill to the “stronger” countries. Like France, Germany, UK and of course the USA. If this disease is left unchecked and it spreads to some of the “Big Boys” it is an absolute lights out event. It would take years to recover from that. This is the most compelling reason for coordinated intervention.
- Could currency intervention achieve anything in the larger picture?
No. And for that reason it probably will not happen. The best intervention could accomplish is buying some time for things to settle down. But if things remain unstable for much longer, the utility of a short-term fix becomes larger.
- Are their any other considerations that might come into the decision?
I think so. Four come to mind:
a) The CDS market has been LEADING this market move. The Central Banks HATE the CDS market and the role that it plays in our economies and in the policy choices. The Central Banks can’t stop that. They have no power. But they could intervene in the currency markets. Because of the way things are connected, a jump in the Euro would also mean a narrowing of the PIIG CDS spreads.
b) Central Bankers have studied the impact of coordinated intervention for years. The biggest conclusion is that intervention can re-establish “two-way risk.” This condition is vital to restoring stability. There has been “no risk” to being short Euros and long PIIG CDS spreads. As long as the perception is out there that there is little or no risk in these directional bets they will continue to move in one direction. Intervention can reestablish the notion of two-way risk. They do that by punishing market players that are constantly pushing the bet farther. CBs hate speculators. They would like nothing better than to catch them off guard and disable them.
c) China is a spectator to this in most respects. But their currency is tied to the dollar. Therefore their currency has just gone up in value by 10%. They hate that. Don’t assume that they have no say in the outcome of this. They would love to see currency intervention solve their problems.
d) If Paul Volker were running the show I think he would say, “Nip this one in the bud”. But Big Paulie is not in charge. Is he?
Will we see this headline?
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